MC Qu. 3 Determinants of Interest Rate for Individual Securities You are Determi

Question

MC Qu. 3 Determinants of Interest Rate for Individual Securities You are Determinants of Interest Rate for Individual Securities You are considering an Investment in 30 year bonds issued by a corporation. The bonds have no special covenants The Wa Street Joumal reports that 1-year T-bills are cumently earning 360 percent Your broker has determined the following information about economic activity and the corporation bonds Real interest rate 2.80% Default risk premium a 2.35% Liquidity risk premlum-100% Maturity risk premium-230% Whet is the infletion premium? Whet is the fair interest rate on the corporation's 30 year bonds? 80% and 905% respectively O 80% and 825%, respectively 80% and 18rs, respectively 360% and 1185%, respectively

Explanation / Answer

A 0.80% and 9.05% respectively.

Inflation premium = yield on T bill - real interest rate

=>3.60 - 2.80 =>0.80%

fair interest rate = inflation premium + real interest rate + default premium + liquidity risk premium + maturity risk premium

=>0.80% + 2.80% + 2.35% + 1.00% + 2.10%

=>9.05%.

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