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%