A particular security’s equilibrium rate of return is 9 percent. For all securities, the inflation risk...
A particular security’s equilibrium rate of return is 9 percent. For all securities, the inflation risk premium is 3.05 percent and the real risk-free rate is 2.9 percent. The security’s liquidity risk premium is 0.55 percent and maturity risk premium is 0.75 percent. The security has no special covenants. Calculate the security’s default risk premium
Homework Answers
Equilibrium rate of return is 9% (i*) = 9%
Inflation risk premium (IP) = 3.05%
Real risk-free rate = 2.9%
Liquidity risk premium = 0.55%
Maturity risk premium = 0.75
Formula for default risk premium is i* = IP + RFR + DRP + LRP + SCP+ MRP
9% = 3.05% + 2.9% + DRP + 0.55% + 0% + 0.75%
Thus, DRP = 9% - 3.05% - 2.9% - 0.55% - 0% -0.75% = 1.75%
Therefore default risk premium is 1.75%.
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