Interest rates A corporation's 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security's liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond's default risk premium?

Question

Quizplus · Accepted Answer

To calculate the bond's default risk premium, we need to subtract the sum of all the other risk premiums (inflation, real interest, liquidity, and maturity) from the equilibrium rate of return:

Default risk premium = Equilibrium rate of return - Sum of all other risk premiums
Default risk premium = 7% - (1.5% + 3.0% + 0.15% + 0.70%)
Default risk premium = 7% - 5.35%
Default risk premium = 1.65%

Therefore, the answer is B, 1.65%.

Interest Rates a Corporation's 10-Year Bonds Have an Equilibrium Rate