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Niendorf Corporation's 5-year bonds yield 7
Niendorf Corporation's 5-year bonds yield 7.30% and 5-year T-bonds yield 5.70%. The real risk-free rate is r* = 3.00%, the inflation premium for 5-year bonds is IP = 2.20%, the liquidity premium for Niendorf's bonds is LP = 0.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t) × 0.10%, where t = number of years to maturity. What is the default risk premium (DRP) on Niendorf's bonds?
a. 1.10%
b. 1.20%
c. 1.30%
d. 1.40%
e. 1.50%
Expert Solution
The MRP formula is :
MRP = (t-1) × 0.10%
MRP = (5 -1) *0.10%
MRP = 0.40%
Real Risk free rate = 3%
Inflation premium = 2.20%
Liquidity premium = 0.20%
5 year yield = 7.30%
DRP = 7.30% - (3% + 2.20% + 0.20% + 0.40%)
DRP = 1.50%
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