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DEFAULT RISK PREMIUM A company's 5-year bonds are yielding 7.9% per year. Treasury bonds with the...

DEFAULT RISK PREMIUM A company's 5-year bonds are yielding 7.9% per year. Treasury bonds with the same maturity are yielding 5.85% per year, and the real risk-free rate (r*) is 2.75%. The average inflation premium is 2.7%, and the maturity risk premium is estimated to be 0.1 x (t - 1)%, where t = number of years to maturity. If the liquidity premium is 1.1%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places.

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Answer #1

Yield on a corporate bond=real risk free rate+liquidity premium+maturity premium+default risk premium+inflation premium

Yield on a Treasury bond=real risk free rate+maturity premium+inflation premium

Hence, yield on a corporate bond-yield on a Treasury bond=liquidity premium+default risk premium

=>7.9%-5.85%=1.1%+default risk premium

=>default risk premium=0.95%

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