A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 4.2 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the security's equilibrium rate of return.

Question

Quizplus · Accepted Answer

The equilibrium rate of return is calculated by summing all the risk premiums and the real interest rate: 3% (default risk) + 1.75% (inflation risk) + 4.2% (real interest rate) + 0.35% (liquidity risk) + 0.95% (maturity risk) = 10.25%.

A Particular Security's Default Risk Premium Is 3 Percent