Question

Urmar Question 23 1 pts Drongo Corporation's 4-year bonds currently yield 4.1 percent and have an inflation premium of 1.4%. The real risk-free rate of interest, r', is 1.4 percent and is assumed to be constant. The maturity risk premium (MRP) is estimated to be 0.1%(t-1), where t is equal to the time to maturity. The default risk and liquidity premiums for this company's bonds total 1 percent and are believed to be the same for all bonds issued by this company. If the average inflation rate is expected to be 1.5 percent for years 5, 6, and 7. what is the yield on a 7-year bond for Drongo Corporation? 4.24% 4.44% 4.84% 04.04% 4,64% nts

Answer 1

Market risk premium 4 year bonds = 0.1%× (4 years - 1) = 0.3%

Inflation premium on 4 year bonds:

Inflation premium = Yield – real risk free rate – market risk premium – liquidity premium

= 4.1% - 1.4% - 0.3% - 1% = 1.4%

Inflation premium for seven years is = (1.4% × 4 + 1.5% × 3] / 7 = 1.44%

Seven year bond:

Market risk premium = 0.1% × (7-1) = 0.6%

Required yield on 7 year bonds = 1.4% + 0.6% + 1% + 1.44% = 4.44%

Answer is 4.44%

Please rate.