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NiikiG's Corporation's 10-year bonds are currently yielding a return of 6.90 percent. The...

Question:

NiikiG's Corporation's 10-year bonds are currently yielding a return of 6.90 percent. The expected inflation premium is 1.30 percent annually and the real risk-free rate is expected to be 2.20 percent annually over the next ten years. The liquidity risk premium on NikkiG's bonds is 0.10 percent. The maturity risk premium is 0.25 percent on 2-year securities and increases by 0.09 percent for each additional year to maturity. Calculate the default risk premium on NikkiG's 10-year bonds.

Risk Premiums:

The risk premium is generally used in the financial markets. This refers to the extra amount the investors should be consented to take the extra risk when they opt for a risk-free investment.

Answer and Explanation:

The yield of the bond is real risk rate + inflation premium + liquidity risk premium+ maturity risk premium +Default risk premium.

6.9% = 2.2% + 1.3% + 0.1% + (0.25%+(0.09% * 8)) + default risk premium.

6.9% = 4.57% + Default risk

So default risk is 2.33%


Learn more about this topic:

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How to Calculate Risk Premium: Definition & Formula

from Financial Accounting: Help and Review

Chapter 5 / Lesson 26
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