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Chapter 6

The document discusses calculations related to bond yields, including default risk premiums for corporate bonds and maturity risk premiums for Treasury securities. It provides specific examples with given interest rates, inflation expectations, and risk premiums to derive the default risk premium and the difference in maturity risk premiums between three-year and five-year Treasury securities. The calculations demonstrate the relationships between various components affecting bond yields.

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36 views2 pages

Chapter 6

The document discusses calculations related to bond yields, including default risk premiums for corporate bonds and maturity risk premiums for Treasury securities. It provides specific examples with given interest rates, inflation expectations, and risk premiums to derive the default risk premium and the difference in maturity risk premiums between three-year and five-year Treasury securities. The calculations demonstrate the relationships between various components affecting bond yields.

Uploaded by

anhplm.yec23
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter 6

6.11 A company’s 5-year bonds are yielding 7% per year. Treasury bonds with the same maturity
are yielding 5.2% per year, and the real risk-free rate (r*) is 2.75%. The average inflation
premium is 2.05%, and the maturity risk premium is estimated to be 0.1 x (t - 1)%, where t =
number of years to maturity. If the liquidity premium is 0.7%, what is the default risk premium
on the corporate bonds?

We have: 𝑟 = 𝑟 ∗ + 𝐼𝑃 + 𝐷𝑅𝑃 + 𝐿𝑃 + 𝑀𝑅𝑃

↔ 7% = 2.75% + 2.05% + 𝐷𝑅𝑃 + 0.7% + [0.1 × (5 − 1)]%


↔ 7% = 2.75% + 2.05% + 𝐷𝑅𝑃 + 0.7% + 0.4%
→ 𝐷𝑅𝑃 = 0.011 = 1.1%

6.12 An investor in Treasury securities expects inflation to be 2.1% in Year 1, 2.7% in Year 2, and
3.65% each year thereafter. Assume that the real risk-free rate is 1.95% and that this rate will
remain constant. Three-year Treasury securities yield 5.20%, while 5-year Treasury securities
yield 6.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities;
that is, what is MRP5 - MRP3?

Three-year Treasury securities

A Treasury security has no default risk premium or liquidity risk premium

We have: 𝑟 = 𝑟 ∗ + 𝐼𝑃 + 𝐷𝑅𝑃 + 𝐿𝑃 + 𝑀𝑅𝑃


2.1% + 2.7% + 3.65%
↔ 5.2% = 1.95% + + 0 + 0 + 𝑀𝑅𝑃3
3
↔ 5.2% = 1.95% + 2.82% + 0 + 0 + 𝑀𝑅𝑃3
→ 𝑀𝑅𝑃3 = 0.43%

5-year Treasury securities

A Treasury security has no default risk premium or liquidity risk premium

We have: 𝑟 = 𝑟 ∗ + 𝐼𝑃 + 𝐷𝑅𝑃 + 𝐿𝑃 + 𝑀𝑅𝑃


2.1% + 2.7% + 3.65% + 3.65% + 3.65%
↔ 6% = 1.95% + + 0 + 0 + 𝑀𝑅𝑃5
5
↔ 6% = 1.95% + 3.15% + 0 + 0 + 𝑀𝑅𝑃5
→ 𝑀𝑅𝑃5 = 0.9%

→ 𝑀𝑅𝑃5 − 𝑀𝑅𝑃3 = 0.9% − 0.43% = 0.47%


6.13 The real risk-free rate, r*, is 1.7%. Inflation is expected to average 1.5% a year for the next 4
years, after which time inflation is expected to average 4.8% a year. Assume that there is no
maturity risk premium. An 11-year corporate bond has a yield of 8.7%, which includes a
liquidity premium of 0.3%. What is its default risk premium?

We have: 𝑟 = 𝑟 ∗ + 𝐼𝑃 + 𝐷𝑅𝑃 + 𝐿𝑃 + 𝑀𝑅𝑃


(1.5% × 4) + (4.8% × 7)
↔ 8.7% = 1.7% + + 𝐷𝑅𝑃 + 0.3%
11
↔ 8.7% = 1.7% + 3.6% + 𝐷𝑅𝑃 + 0.3%
↔ 𝐷𝑅𝑃 = 3.1%

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