Suppose the real risk-free rate is 2.5%, the average future inflation rate is 2.3%, a maturity premium of 0.07% per year to maturity applies, i.e., MRP = 0.07% (t), where t is the years to maturity. Suppose also that a liquidity premium of 1% and a default risk premium of 0.7% applies to A-rated corporate bonds. How much higher would the rate of return be on a 7-year A-rated corporate bond than on a 5-year Treasury bond. Here we assume that the pure expectations theory is NOT valid.

Suppose the real risk-free rate is 2.5%, the average future inflation rate is 2.3%, a maturity premium of 0.07% per year to maturity applies, i.e., MRP = 0.07% (t), where t is the years to maturity. Suppose also that a liquidity premium of 1% and a default risk premium of 0.7% applies to A-rated corporate bonds. How much higher would the rate of return be on a 7-year A-rated corporate bond than on a 5-year Treasury bond. Here we assume that the pure expectations theory is NOT valid.

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter4: Bond Valuation

Section: Chapter Questions

Problem 19P

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