If 10-year T-bonds have a yield of 6.3%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.5% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
Question 19Select one:

a.
1.90%

b.
1.70%

c.
2.30%

d.
2.53%

e.
2.78%

To calculate the **default risk premium (DRP)** on the corporate bond, we need to use the following relationship for the yield on corporate bonds:

\[
\text{Corporate bond yield} = \text{T-bond yield} + \text{Default risk premium} + \text{Liquidity premium} + \text{Maturity risk premium}
\]

We are given the following dataTo calculate the **default risk premium (DRP)** on the corporate bond, we need to use the following relationship for the yield on corporate bonds:

\[
\text{Corporate bond yield} = \text{T-bond yield} + \text{Default risk premium} + \text{Liquidity premium} + \text{Maturity risk premium}
\]

We are given the following 
- **T-bond yield** = 6.3%
- **Corporate bond yield** = 8.5%
- **Maturity risk premium (MRP)** = 1.3% (same for both T-bonds and corporate bonds)
- **Liquidity premium (LP)** on corporate bonds = 0.5%, and for T-bonds = 0% (no liquidity premium)

Now, rearranging the formula to solve for the **default risk premium (DRP)**:

\[
\text{Default risk premium} = \text{Corporate bond yield} - \text{T-bond yield} - \text{Liquidity premium} - \text{Maturity risk premium}
\]

Substituting the given values:

\[
\text{Default risk premium} = 8.5\% - 6.3\% - 0.5\% - 1.3\%
\]

Let's calculate that:

\[
\text{Default risk premium} = 8.5\% - 6.3\% - 0.5\% - 1.3\% = 0.4\%
\]

So, the **default risk premium** on the corporate bond is **0.4%**.

This is quite far from the provided answer choices, so there might be an error. Let me check again or verify...

If 10-year T-bonds have a yield of 6.3%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.5% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?

Learn how to calculate the default risk premium on a 10-year corporate bond. Given data includes a 6.3% T-bond yield, 8.5% corporate bond yield, 1.3% maturity risk premium, and 0.5% liquidity premium. Understand the relationship between bond yields and risk premiums using financial algebra. Suitable for undergraduate finance students.

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