Unformatted text preview: l 10-year bonds is 1.1%, and corporate bonds have a 0.2% liquidity premium versus a zero liquidity
premium for T-bonds, what is the default risk premium on the corporate bond?
1.00% T bond yield
DRP Problem 5:
Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, a maturity premium of
0.08% per year to maturity applies, i.e., MRP = 0.08%(t), where t is the years to maturity. Suppose also that
a liquidity premium of 0.5% and a default risk premium of 0.85 applies to A-rated corporate bonds. How
much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5-year Treasury
bond. Here we assume that the pure expectations theory is NOT valid? Disregard cross-product terms, i.e.,
if averaging is required, use the arithmetic average.
MRP, 5-year T-bond
MRP, 10-year corporate
A bond yield
Difference Per year:
Per year: 0.08%
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