A treasury bond that matures in 10 years has a yield of 6%. A 10 year corporate bond has a yield of 9%. assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?
2.5%
To calculate the default risk premium on the corporate bond, we need to start by calculating the risk-free rate, which is the yield of the treasury bond.
Given that the treasury bond has a yield of 6% and the corporate bond has a yield of 9%, we can determine that the risk-free rate is 6%.
Next, we need to calculate the liquidity premium. In this case, the liquidity premium of the corporate bond is 0.5%.
To find the default risk premium, we need to subtract the risk-free rate and the liquidity premium from the yield of the corporate bond.
Default Risk Premium = Yield of Corporate Bond - Risk-Free Rate - Liquidity Premium
Default Risk Premium = 9% - 6% - 0.5%
Default Risk Premium = 2.5%
Therefore, the default risk premium on the corporate bond is 2.5%.
To determine the default risk premium on the corporate bond, we need to subtract the risk-free rate from the corporate bond yield, and then subtract the liquidity premium.
Step 1: Find the risk-free rate
The risk-free rate is represented by the yield on the Treasury bond. In this case, the yield on the Treasury bond is given as 6%.
Step 2: Find the corporate bond yield
The corporate bond yield is given as 9%.
Step 3: Find the liquidity premium
The liquidity premium on the corporate bond is given as 0.5%.
Step 4: Calculate the default risk premium
The default risk premium is simply the difference between the corporate bond yield and the risk-free rate, and then subtracting the liquidity premium.
Default Risk Premium = Corporate Bond Yield - Risk-free Rate - Liquidity Premium
= 9% - 6% - 0.5%
= 2.5%
Therefore, the default risk premium on the corporate bond is 2.5%.