A 5-year Treasury bond has a 4

Finance Sep 14, 2020

A 5-year Treasury bond has a 4.1% yield. A 10-year Treasury bond yields 6.8%, and a 10-year corporate bond yields 9.45%. The market expects that inflation will average 1.5% over the next 10 years (IP10 = 1.5%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described. What is the yield on this 5-year corporate bond? Round your answer to two decimal places.

Expert Solution

Yield on 5- year corporate bond= Yield on 5 year Treasury bond +Yield on 10 year corporate bond- Yield on 10 year Treasury bond

=4.1%+ 9.45%- 6.8%

= 6.75%

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