A company's 5-year bonds are yielding 7.75% per year.

Treasury bonds with the same maturity are

yielding 5.2% per year, and the real risk-free rate is 2.3%. The average inflation premium is 2.5%; and the
maturity risk premium is estimated to be 0.1* (t-1)%, where t=number of years to maturity. If the
liquidity premium is 1%, what is the default risk premium on the corporate bonds?
• MRP = 0.1%(5 - 1) = 0.4%
• r= r* + IP + DRP + LP + MRP
7.75% = 2.3% + 2.5% + 0.4% + 1.0% + DRP
DRP = 1.55%.
You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.5%. Your brother-in-law, a
broker at Safe and Sound Securities, has given the following estimates of current interest rate
premiums:
Inflation premium = 3.25%
Liquidity premium =0.6%
Maturity risk premium = 1.8%
Default risk premium = 2.15%
What is the real risk-free rate of return?
T-bill rate = r* + IP
5.5% = r* + 3.25%
r*
= 2.25%.
The real risk-free rate of interest is 3%; and it is expected to remain constant over time. Inflation is
expected to be 2% per year over the next 3 years and 4% per year from year 4 to year 9. The maturity
risk premium is equal to 0.1*(t-1)%, where t=bond's maturity. The default risk premium for a BBB-rated
bond is 1.3%.
What is the average expected inflation rate over the next 4 years?
What is the vield on a 4-year treasury bond?
What is the yield on a 4-year BBB-rated corporate bond with a liquidity premium of 0.5%?
Average expected inflation:
(2%*3+4%)/4=2.5%
For T-Bond: r= r* + IP + MRP= 3%+2.5%+0.1*3% =5.8%
For corporate bond: r= r* + IP + DRP + LP + MRP = 5.8%
+DRP+LP = 5.8%+ 0.5% + 1.3% = 7.6%