QUESTION 4

Part A: Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.65%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds?

a. 1.22%

b. 1.10%

c. 1.34%

d. 0.86%

e. 1.20%

Part B: Koy Corporation's 5-year bonds yield 8.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t 1) 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy's bonds?

a. 2.16%

b. 2.10%

c. 2.12%

d. 2.48%

e. 2.18%