Tootsie Roll Industries' 10-year bonds are priced to yield 7%.Economists predict that real rates and inflation will remain constant over the next ten years at 3% and 2%,respectively.Bond analysts estimate that the maturity risk premium for a 10-year maturity is 0.25% and that the liquidity risk premium for Tootsie's bond is 0.50%.What is the default risk premium for Tootsie's bond?

Question

Quizplus · Accepted Answer

YTM = k_r + INF + MRP + LRP + DRP DRP = YTM - k_r - π - k_r × π - MRP - LRP DRP = 0.07 - 0.03 - 0.02 - (0.03 × 0.02) - 0.0025 - 0.005 DRP = 0.0119 or 1.19%

Tootsie Roll Industries' 10-Year Bonds Are Priced to Yield 7