Problem: You read in the Wall Street Journal that a 30 day T-bill currently is yielding 8%. Your brother in law, a broker for Madoff Investments has given you the following estimates of current interest rate premiums.
Inflation Premium 5%
Liquidity Premium 1%
Maturity Risk Premium 2%
Default Risk Premium 2%
1) Based on these data, what is the real risk free rate of return?
2) What is the yield on a one year corporate bond with a $1000 face value that pays a 12% annual dividend if it was purchased for $950 and held until maturity?
3) If you require a 20% yield on a one year corporate bond with a $1000 face value and a 12% annual premium what is the most you should be willing to pay for this bond?