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Homework answers / question archive / A treasury bond that matures in 10 years has a yield of 3%
A treasury bond that matures in 10 years has a yield of 3%. A 10-year corporate bond has a yield of 5%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?
(Hint: For a treasury bond, Liquidity premium = Default Risk Premium = 0. Here, treasury and corporate bonds have the same inflation premium and maturity risk premium since they both mature in 10 years. So, the difference between the 10-year corporate yield and 10-year treasury yield should be equal to the sum of the liquidity premium and default risk premium on the 10-year corporate bond.)
Selected Answer: 2%
Answers:
1.5%
2%
2.5%
3%
Computation of Default Risk Premium:
Given,
Yield on Corporate Bond = 5%
Risk-free Rate = 3%
Liquidity Premium = 0.50%
Yield on Corporate Bond = Risk-free Rate + Liquidity Premium + Default Risk Premium
5% = 3%+0.50%+ Default Risk Premium
5% = 3.50% + Default Risk Premium
Default Risk Premium = 5%-3.50% = 1.50%
