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The interest rate on a 20-year Treasury bond is 9.25 percent. A comparable maturity, Aaa-rated corporate bond is yielding 10 percent. Another comparable maturity, but lower-quality corporate bond has a yield of 14 percent, which includes a liquidity premium of 1.5 percent. a. Determine the default risk premium on the Aaa-rated bond. b. Determine the default risk premium on the

Chapter 8, Problems #13

The interest rate on a 20-year Treasury bond is 9.25 percent. A comparable maturity, Aaa-rated corporate bond is yielding 10 percent. Another comparable maturity, but lower-quality corporate bond has a yield of 14 percent, which includes a liquidity premium of 1.5 percent.

a. Determine the default risk premium on the Aaa-rated bond.

b. Determine the default risk premium on the lower-quality corporate bond.

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Related Book For answer-question
Introduction to Finance Markets, Investments and Financial Management

Introduction to Finance Markets, Investments and Financial Management

16th edition

Authors: Ronald W. Melicher, Edgar A. Norton

ISBN: 978-1119398288

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Bond valuation is the process of determining the worth of a bond. It is based on the present value of the bond\'s future cash flows, which include coupon payments and the return of the bond\'s face value (or \"principal\") at maturity. The discount rate used in the calculation is directly tied to prevailing interest rates, and a rise in interest rates will decrease the present value of the bond and thus lower its price. Conversely, a fall in interest rates will increase the present value of the bond and raise its price. Interest rates serve as a benchmark for determining the value of a bond, as they determine the discount rate used in the bond valuation calculation. The most commonly used measure of interest rates is the yield to maturity (YTM), which represents the internal rate of return of an investment in a bond if the investor holds the bond until maturity and receives all scheduled payments. Yield to maturity is a function of the coupon rate, the current market price of the bond, the face value of the bond, and the number of years remaining until maturity. By comparing the yield to maturity of a bond to prevailing market interest rates, an investor can assess the relative value of the bond.

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