You are considering an investment in 20year bonds issued by

You are considering an investment in 20-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 0.30 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:

What is the inflation premium? (Round your answer to 2 decimal places. (e.g., 32.16))

What is the fair interest rate on Moore Corporation 30-year bonds? (Round your answer to 2 decimal places. (e.g., 32.16))

Solution

a). Inflation Premium = Nominal Risk-Free Rate - Real Risk-Free Rate

= 0.30% - 0.21% = 0.09%

b). Interest Rate = Real Risk-Free Rate + Inflation Premium + Default Risk Premium + Liquidity Risk Premium + Maturity Risk Premium

= 0.21% + 0.09% + 1.15% + 0.80% + 0.75% = 3.00%