Question

Op corporation's 5-year bonds yield 6.50%, and t-bonds with the same maturity yield 4.40%. the default risk premium for kop's bonds is drp = 0.40%, the liquidity premium on kop's bonds is lp = 1.70% versus zero on t-bonds, the inflation premium (ip) is 1.50%, and the maturity risk premium (mrp) on 5-year bonds is 0.40%. what is the real risk-free rate, r*?

Answer 1

The yield on a company's bonds, r is given by: r = r* + drp + lp + ip + mrp For Kop's bonds, r = 6.5%, drp = 0.4%, lp = 1.7%, ip = 1.5% and mrp = 0.4%. Therefore, r* = 2.5%

Answer 2

The risk-free rate is 2.5%

Further Explanation:

Risk-free rate: It refers to the an of return that can be earned by the financial instrument which has no default risk.

Calculate the risk free rate:  

Default risk premium (D) = 0.4 %

Liquidity premium (L)   = 1.7%

Inflation premium (I)   = 1.5%

Maturity risk premium (P) = 0.4%

Risk free rate = r

Yield on bond = r + D + L + I + P

             6.5% = r + 0.4 % + 1.7% + 1.5% + 0.4%

                    r = 6.5% - 4%

                   r = 2.5%

Thus, the risk-free rate is 2.5%

Learn more:

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Answer details:

Grade: High School

Subject: Financial Management

Chapter: Risk and Return

Keywords: Op corporation's 5-year bonds yield 6.50%, and t-bonds with the same maturity yield 4.40%. The default risk premium for kop's bonds is 0.40%, the liquidity premium on kop's bonds is 1.70% versus zero on t-bonds, the inflation premium is 1.50%, and the maturity risk premium on 5-year bonds is 0.40%. The real risk-free rate, financial management, risk and return, bond rate, Yield on bond.