6. Bond Return

6. Bond Return - Yield (Required Rate of Return) on an...

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Yield (Required Rate of Return) on an Individual Fixed-income Security r i = r* + IP + DRP i + MP i + LP t r i = 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, ignoring inflation and all risks. The real risk-free rate of return is economy-wide, i.e. not specific to the individual firm. The real risk-free rate of return represents the required compensation for foregone consumption, i.e. the time value of consumption. IP = inflation premium. This is the annual average expected inflation over the life of the security. The inflation premium is economy-wide, i.e. not specific to the individual firm. r RF = nominal risk-free rate of return. By definition, r RF = r* + IP. The nominal risk- free rate of return is economy-wide, i.e. not specific to the individual firm. The nominal risk-free rate of return represents compensation for foregone consumption (r*) plus compensation for expected inflation (IP). The nominal
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