Yield (Required Rate of Return) onan Individual Fixed-income Securityri= r*+ IP + DRPi+ MPi+ LPtri= nominal yield on security, i.e. the cost of debt for the firm.r* =real risk-free rate of return. This is the rate of return on the security, ignoringinflation and all risks. The real risk-free rate of return is economy-wide, i.e. notspecific to the individual firm. The real risk-free rate of return represents therequired compensation for foregone consumption, i.e. the time value ofconsumption.IP=inflation premium. This is the annual average expectedinflation over the life ofthe security. The inflation premium is economy-wide, i.e. not specific to theindividual firm.rRF= nominal risk-free rate of return. By definition, rRF= r* + IP. The nominal risk-free rate of return is economy-wide, i.e. not specific to the individual firm. Thenominal risk-free rate of return represents compensation for foregoneconsumption (r*) plus compensation for expected inflation (IP). The nominal
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