Question

A particular security's default risk premlum is 3 percent. For all securities, the inflation risk premium is 2.75 percent and the real riskfree rate is 2.90 percent. The security's liquidity risk premium is 0.25 percent and maturity risk premium is 0.85 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 security's equilibrium rate of return is calculated by summing the real risk-free rate and all applicable risk premiums. In this case, the equilibrium rate of return is 9.75%.

Step-by-step explanation:

The student asked how to calculate the security's equilibrium rate of return. To find this, one would add the real risk-free rate to various risk premiums associated with the security. The formula for calculating the equilibrium rate of return is as follows:

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

Using the provided information, the calculation is:

Equilibrium Rate of Return = 2.90% (Real Risk-Free Rate) + 2.75% (Inflation Risk Premium) + 3.00% (Default Risk Premium) + 0.25% (Liquidity Risk Premium) + 0.85% (Maturity Risk Premium)

After adding all the components together:

Equilibrium Rate of Return = 9.75%

Therefore, the security's equilibrium rate of return, rounded to two decimal places, is 9.75% percent.