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Q1) Assume that a $1,000 three year T-Note is currently trading at $914

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Q1) Assume that a $1,000 three year T-Note is currently trading at $914.61 Ignoring income tax considerations, and assuming that investors require additional 0.4% liquidity risk premium to buy and hold corporate securities rather than T-securities, please calculate default risk premium (DRP) on a $1,000 three year BB+ rated corporate note currently trading at $839.62 Note: Standard rounding applies A). 2.98% B). 3.60% C). 5.60% D). 2.58% E). 3.42% Solution: T-Note YTM = ($1,000 / $914.61)^(1/3) - 1 = 3.02% BB+ Corp YTM = ($1,000 / $839.62)^(1/3) - 1 = 6.00% T-Note YTM = i = r + Pi + r*Pi BB+Corp YTM = i = r+ Pi + r*Pi + DRP + LRP To get to DRP we subtract from BB+ corp YTM first LRP, and then T-Note YTM BB+ Crop YTM adjusted for LRP is 6.0% - 0.4% = 5.6% - minus T-Note 3.02 = 2.58%