   Chapter 6, Problem 5P Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

MATURITY RISK PREMIUM The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-ycar Treasury security yields 6.2%. What is the maturity risk premium for the 2-year security?

Summary Introduction

To identify: The maturity risk premium.

Maturity Risk Premium: A premium, which is paid by the borrower to its lender in the form of compensation of interest rate uncertainty in the regards of maturity risk is known as maturity risk premium.

Explanation

Solution:

The items required for the calculation of maturity risk are risk free rate, Treasury bill yield and inflation premium.

Given,

The corporate bond yield is 6.2%.

The risk free rate is 3%.

The inflation premium is 3%.

Formula to calculate the maturity risk premium derives from the formula of corporate bond yield,

r=r*+IP+MRPMRP=r(r*+IP)

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