The Wall Street Journal reports that the current rate on 8-year Treasury bonds is 5.85 percent, on 15-year Treasury bonds is 6.25 percent, and on a 15-year corporate bond issued by MHM Corp. is 7.35 percent. Assume that the maturity
risk premium is zero. If the default risk premium and liquidity risk premium on an 8-year corporate bond issued by MHM Corp. is the same as those on the 15-year corporate bond, calculate the current rate on MHM Corp.’s 8-year corporate bond.
To calculate the current rate on MHM Corp.'s 8-year corporate bond, we need to take into account the information provided in the question.
First, we know the rates on 8-year Treasury bonds, 15-year Treasury bonds, and a 15-year corporate bond issued by MHM Corp.
The current rate on 8-year Treasury bond is 5.85 percent.
The current rate on 15-year Treasury bond is 6.25 percent.
The current rate on a 15-year corporate bond issued by MHM Corp. is 7.35 percent.
Next, we need to consider the default risk and liquidity risk premium. According to the question, the default risk premium and liquidity risk premium on the 15-year corporate bond issued by MHM Corp. are the same as those on the 8-year corporate bond.
Since the maturity risk premium is given as zero, we can assume that the default risk premium and liquidity risk premium are the only factors affecting the difference in rates.
To calculate the current rate on MHM Corp.'s 8-year corporate bond, we need to find the difference between the rates of the 8-year Treasury bond and the 15-year Treasury bond, and add it to the rate of MHM Corp.'s 15-year corporate bond.
Default risk premium and liquidity risk premium = Rate of 15-year corporate bond issued by MHM Corp. - Rate of 15-year Treasury bond
Default risk premium and liquidity risk premium = 7.35% - 6.25% = 1.10%
Now, we can calculate the rate on MHM Corp.'s 8-year corporate bond:
Rate on MHM Corp.'s 8-year corporate bond = Rate of 8-year Treasury bond + Default risk premium and liquidity risk premium
Rate on MHM Corp.'s 8-year corporate bond = 5.85% + 1.10%
Rate on MHM Corp.'s 8-year corporate bond = 6.95%
Therefore, the current rate on MHM Corp.'s 8-year corporate bond is estimated to be 6.95 percent.