Problem:
Rachel's 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Keys' bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) x 0.1%, where t = number of years to maturity.
Required:
Question: What is the default risk premium (DRP) on Keys' bonds?
- 0.99%
- 1.10%
- 1.21%
- 1.33%
- 1.46%
Note: Show all workings.