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You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 2.15 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:

Real risk-free rate = 0.75%
Default risk premium = 2.05%
Liquidity risk premium = 1.40%
Maturity risk premium = 2.65%

Required:
a. What is the inflation premium?
b. What is the fair interest rate on Moore Corporation 30-year bonds?

Respuesta :

abiolataiwo2015

Answer:

a. 1.40%

b. 8.25%

Explanation:

a. Calculation to determine the inflation premium

Using this formula

Expected IP = i - RIR

Let plug in the formula

Expected IP = 2.15% - 0.75%

Expected IP= 1.40%

Therefore the inflation premium is 1.40%

b. Calculation to determine the fair interest rate on Moore Corporation 30-year bond

Using this formula

Fair interest rate=Default risk premium +Liquidity risk premium+Maturity risk premium +T-bills are currently earning

Let Plug in the formula

Fair interest rate=2.05%+ 1.40%+ 2.65% + 2.15%

Fair interest rate= 8.25%

Therefore the fair interest rate on Moore Corporation 30-year bond is 8.25%

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