Unformatted text preview: l 10year bonds is 1.1%, and corporate bonds have a 0.2% liquidity premium versus a zero liquidity
premium for Tbonds, what is the default risk premium on the corporate bond?
5.20%
7.50%
1.10%
0.20%
1.00% T bond yield
Corporate yield
MRP
LP
DRP Problem 5:
Suppose the real riskfree 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 Arated corporate bonds. How
much higher would the rate of return be on a 10year Arated corporate bond than on a 5year Treasury
bond. Here we assume that the pure expectations theory is NOT valid? Disregard crossproduct terms, i.e.,
if averaging is required, use the arithmetic average.
r*
IP
MRP, 5year Tbond
MRP, 10year corporate
LP
DRP
Tbond yield
A bond yield
Difference Per year:
Per year: 0.08%
0.08% Years:
Years: 5
10 3.50%
2.25%
0.40%...
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 Winter '08
 Brinkley,G
 Inflation, Yield Curve, default risk premium

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