Question

A particular security’s default risk premium is 4 percent. For all securities, the inflation risk premium is 3.85 percent and the real risk-free rate is 2.90 percent. The security’s liquidity risk premium is 0.15 percent and maturity risk premium is 0.75 percent. The security has no special covenants. Calculate the security’s equilibrium rate of return. (Round your answer to 2 decimal places.)

Answer 1

The equilibrium rate of return for the security is 11.65%.

Step-by-step explanation:

The equilibrium rate of return for a security can be calculated by summing up all the risk premiums and adding them to the real risk-free rate. In this case, the default risk premium is 4 percent, the inflation risk premium is 3.85 percent, the real risk-free rate is 2.90 percent, the liquidity risk premium is 0.15 percent, and the maturity risk premium is 0.75 percent. Therefore, the equilibrium rate of return for the security is:

Equilibrium Rate of Return = Default Risk Premium + Inflation Risk Premium + Real Risk-Free Rate + Liquidity Risk Premium + Maturity Risk Premium

= 4% + 3.85% + 2.90% + 0.15% + 0.75% = 11.65%