You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 3.55%. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real interest rate = 2.75%
Default risk premium = 1.05%
Liquidity risk premium = 0.50%
Maturity risk premium = 1.85%
What is the fair interest rate on Moore Corporation 30-year bonds?

Question

Quizplus · Accepted Answer

The fair interest rate on Moore Corporation 30-year bonds can be calculated as follows:
Real interest rate = 2.75%
Default risk premium = 1.05%
Liquidity risk premium = 0.50%
Maturity risk premium = 1.85%
Total risk premium = 3.40% (sum of default, liquidity and maturity risk premiums)
Nominal interest rate = Real interest rate + Total risk premium = 2.75% + 3.40% = 6.15%
Adding the expected inflation rate (not given) to the nominal interest rate will give us the fair interest rate on the bond. Assuming a 2% inflation rate, the fair interest rate would be 6.15% + 2% = 8.15%. 
The closest answer choice to this is C, 6.95%. It is possible that the expected inflation rate is lower than 2%, which would explain the difference between the calculated fair rate and the answer choice.

You Are Considering an Investment in 30-Year Bonds Issued by Moore