A German investor recently purchased a U.S. blue-chip, A-rated corporate bond with a 10-year maturity. The yield on the bond is 8.2 percent. The default risk premium is 0.5 percent and the liquidity premium is 0.1 percent. The real risk-free rate of return is 2.8 percent and the inflation premium (calculated over 10 years) is 3.3 percent. The maturity risk premium is 1.0 percent, and the country risk premium is 0.3 percent. The nominal risk-free rate of return is 6.1 percent. Given these data, what was the exchange rate risk premium (ERP) on the bond?

Question

Quizplus · Accepted Answer

The exchange rate risk premium (ERP) is the difference between the nominal risk-free rate of return in the investor's home country and the nominal risk-free rate of return in the country where the bond is issued. In this case, the investor is German and the bond is issued in the U.S. The nominal risk-free rate of return in Germany is 6.1 percent and the nominal risk-free rate of return in the U.S. is 6.1 percent. Therefore, the ERP is 0.2 percent.

A German Investor Recently Purchased a U