Nikki G's Corporation's 10-year bonds are currently yielding a return of 9.25 percent. The expected inflation premium is 2.0 percent annually and the real interest rate is expected to be 3.10 percent annually over the next 10 years. The liquidity risk premium on Nikki G's bonds is 0.1 percent. The maturity risk premium is 0.10 percent on two-year securities and increases by 0.05 percent for each additional year to maturity. Calculate the default risk premium on Nikki G's 10-year bonds.

Question

Quizplus · Accepted Answer

The yield on Nikki G's 10-year bonds can be broken down into several components: the real interest rate, the inflation premium, the liquidity risk premium, the maturity risk premium, and the default risk premium. The maturity risk premium for a 10-year bond is 0.10% + (0.05% * (10-2)) = 0.50%. Adding up the known components: real interest rate (3.10%) + inflation premium (2.0%) + liquidity risk premium (0.1%) + maturity risk premium (0.50%) = 5.70%. Subtracting this total from the bond's yield (9.25%) gives the default risk premium: 9.25% - 5.70% = 3.55%.

Nikki G's Corporation's 10-Year Bonds Are Currently Yielding a Return