Need The Solution Nikki G's Corporations 10-Year Bonds Are C
Need The Solutionnikki Gs Corporations 10 Year Bonds Are Currently Y
Need the solution Nikki G’s Corporation’s 10-year bonds are currently yielding a return of 6.35 percent. The expected inflation premium is 1.05 percent annually and the real interest rate is expected to be 2.70 percent annually over the next ten years. The liquidity risk premium on Nikki G’s bonds is 0.55 percent. The maturity risk premium is 0.20 percent on 4-year securities and increases by 0.09 percent for each additional year to maturity. Calculate the default risk premium on Nikki G’s 10-year bonds. (Round your answer to 2 decimal places.)
Paper For Above instruction
The calculation of the default risk premium on Nikki G’s 10-year bonds involves understanding how to decompose the bond's yield into its constituent risk and return components. Given the total yield, the known premiums—such as the inflation premium, real interest rate, liquidity risk premium, and maturity risk premium—can be Subtracted sequentially to isolate the default risk premium, which compensates investors for the risk that the issuer might fail to meet its debt obligations.
First, it is essential to understand the information provided:
- The current yield on Nikki G’s bonds: 6.35%
- Expected inflation premium: 1.05%
- Real interest rate: 2.70%
- Liquidity risk premium: 0.55%
- Maturity risk premium for 4-year securities: 0.20%. It increases by 0.09% for each additional year of maturity, which applies to the 10-year bonds.
The total bond yield can be expressed as the sum of various premiums:
Total Yield = Real Interest Rate + Expected Inflation Premium + Maturity Risk Premium + Liquidity Risk Premium + Default Risk Premium
The maturity risk premium (MRP) for the 10-year bonds needs to be calculated considering it increases by 0.09% per year over 4 years:
- MRP = 0.20% + (10 - 4) × 0.09%
- MRP = 0.20% + 6 × 0.09%
- MRP = 0.20% + 0.54%
- MRP = 0.74%
Next, summing the known premiums:
- Real interest rate: 2.70%
- Expected inflation premium: 1.05%
- Maturity risk premium: 0.74%
- Liquidity risk premium: 0.55%
Total known premiums:
2.70% + 1.05% + 0.74% + 0.55% = 5.04%
The overall yield is 6.35%, so:
- Default risk premium = Total yield - Sum of known premiums
- Default risk premium = 6.35% - 5.04% = 1.31%
Therefore, the default risk premium on Nikki G’s 10-year bonds is approximately 1.31%. This premium compensates investors for the potential risk that Nikki G’s Corporation might default on its obligations, which is an important component of bond valuation.
In conclusion, understanding how to decompose bond yields into component premiums provides investors with insight into the risk profile of a specific security. The default risk premium of 1.31% indicates a moderate level of default risk perceived by the market for Nikki G’s bonds, aligning with typical expectations for corporate bonds with similar characteristics.
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