You are considering an investment in a one year government debt security with a yeild od 5% or a highly liquid corporate debt security with a yeild of 6.5%. The expected inflation rate for the next year is expected to be 2.5%.
A. what would be your real rate earned on either of the tow investments?
B. what would be the default risk premium o the corporate debt security?
You are considering an investment in a one year government debt security with a yeild od 5% or a highly liquid corporate debt security with a yeild of 6.5%. The expected inflation rate for the next year is expected to be 2.5%.
A. what would be your real rate earned on either of the tow investments?
B. what would be the default risk premium o the corporate debt security?
You are considering an investment in a one year government debt security with a yeild od 5% or a highly liquid corporate debt security with a yeild of 6.5%. The expected inflation rate for the next year is expected to be 2.5%.
A. what would be your real rate earned on either of the tow investments?
B. what would be the default risk premium o the corporate debt security?
Answer this Question
A. To calculate the real rate earned on either investment, you need to adjust for inflation. The real rate is the nominal rate (yield) minus the inflation rate.
For the government debt security:
Real rate = Nominal rate - Inflation rate
Real rate = 5% - 2.5% = 2.5%
For the corporate debt security:
Real rate = Nominal rate - Inflation rate
Real rate = 6.5% - 2.5% = 4%
So, the real rate earned on the government debt security is 2.5%, and the real rate earned on the corporate debt security is 4%.
B. The default risk premium is the additional return that investors require to compensate for the higher risk of default associated with corporate debt compared to government debt.
Default Risk Premium = Corporate Debt Yield - Government Debt Yield
Default Risk Premium = 6.5% - 5% = 1.5%
Therefore, the default risk premium for the corporate debt security is 1.5%.