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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.8%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

  • Inflation premium = 3.25%
  • Liquidity premium = 0.6%
  • Maturity risk premium = 1.85%
  • Default risk premium = 2.15%

On the basis of these data, what is the real risk-free rate of return?

Summary Introduction

To identify: The real risk-free return.

Introduction:

Real Risk-Free Rate:

A rate of minimum return that is required by an investor without any risk of losing the money due to market conditions is known as the real risk free return rate.

Explanation

The items required for the calculation of real risk-free return are the current interest rate of security and the inflation premium.

Given,

The current interest is 5.8%.

The inflation premium is 3.25%.

Formula to calculate the real risk-free rate is derived from the formula of interest rate.

r=r*+IPr*=rIP

Where,

  • r is the interest rate of treasury bills

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