Question

A Treasury Bond that matures in 10 years has a yield of 6 percent. A 10-year corporate

bond has a yield of 8 percent. Assume that the liquidity premium on the corporate bond
is 0.5%. What is the default risk premium on the corporate bond?

Answer 1

The default risk premium on the corporate bond is 1.5%, calculated by subtracting the Treasury bond yield and the liquidity premium from the corporate bond yield (8% - 6% - 0.5%).

Step-by-step explanation:

The question is asking to calculate the default risk premium on a corporate bond, given that a 10-year Treasury bond has a yield of 6 percent and a 10-year corporate bond has a yield of 8 percent, including a liquidity premium of 0.5 percent.

To find the default risk premium, we subtract the treasury bond yield and the liquidity premium from the corporate bond yield: Corporate Bond Yield - Treasury Bond Yield - Liquidity Premium = Default Risk Premium.

In this case, the default risk premium calculation would be: 8% (Corporate Bond Yield) - 6% (Treasury Bond Yield) - 0.5% (Liquidity Premium) = 1.5%. So, the default risk premium on the corporate bond is 1.5%.