Interest rates You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation bonds: Real interest rate = 2.50%
Default risk premium = 1.75%
Liquidity risk premium = 0.70%
Maturity risk premium = 1.50%
What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds?

Question

Quizplus · Accepted Answer

The inflation premium is calculated by subtracting the real interest rate from the T-bill rate: 3.50% - 2.50% = 1%. The fair interest rate on the corporation's 30-year bonds is the sum of all premiums: 2.50% (real rate) + 1.75% (default risk) + 0.70% (liquidity risk) + 1.50% (maturity risk) + 1% (inflation premium) = 7.45%.

Interest Rates You Are Considering an Investment in 30-Year Bonds