Question

Dakota Corporation 15-year bonds have an equilibrium rate of return of 10 percent. For all securities, the inflation risk premium is 1.75 percent and the real risk-free rate is 3.50 percent. The security’s liquidity risk premium is 1.20 percent and maturity risk premium is 1.80 percent. The security has no special covenants. Calculate the bond’s default risk premium. (Round your answer to 2 decimal places.)

Answer 1

Bond Yield = 10.00%
Inflation Risk Premium = 1.75%
Real Risk-free Rate = 3.50%
Liquidity Risk Premium = 1.20%
Maturity Risk Premium = 1.80%

Bond Yield = Inflation Risk Premium + Real Risk-free Rate + Liquidity Risk Premium + Maturity Risk Premium + Default Risk Premium
10.00% = 1.75% + 3.50% + 1.20% + 1.80% + Default Risk Premium
10.00% = 8.25% + Default Risk Premium
Default Risk Premium = 1.75%