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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

MATURITY RISK PREMIUM The real risk-free rate is 2.5% and inflation is expected to be 2.75% for the next 2 years. A 2-year Treasury security yields 5.55%. What is the maturity risk premium for the 2-year security?

Summary Introduction

To identify: The maturity risk premium.

Introduction:

Maturity Risk Premium:

A premium, which a borrower pays to the lender in the form of compensation of interest rate uncertainty in regards of maturity risk is known as the maturity risk premium.

Explanation

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

Given,

The treasury security yield is 5.55%.

The risk free rate is 2.5%.

The inflation premium is 2.75%.

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

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

Where,

  • MRP is the maturity risk premium

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