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QUESTION 1

You are a newly appointed junior bond analyst who has been provided with the information below relating to two fixed income securities Bond Alpha and Bond Vega:

Characteristic	Bond Alpha	Bond Vega
Time to maturity (years)	5	12
Inflation expectation premium	9%	8%
Risk premium for:
Liquidity risk	2%	2%
Default risk	1%	1.5%
Maturity risk	0.5%	1%
Other risk	0.5%	1%

The real rate of interest is currently 2%.

Calculate the following:

1. Risk-free rate for each security
2. Total risk premium for each securitys issuer and issue characteristics
3. Nominal rate of interest for each security

QUESTION 2

1. Eleanor Burns is attempting to find the nominal interest rate for each of the two bonds below issued by different firms at the same point in time:

Characteristic	Bond A	Bond B
Time to maturity	2 years	20 years
Inflation Expectation premium	9%	7%
Bond rating	Baa	Ba

Additional information provided

Bonds	Nominal rate of interest
US Treasury Bonds (average)	1.20%
Corporate Bonds (using risk ratings)
High quality (Aaa-Aa)	2.31%
Medium quality (A-Baa)	4.12%
Speculative (Ba-C)	8.14%

1. If the real interest rate is currently 2%, find the risk-free interest rate applicable to each bond.
2. Find the risk premium for each bond
3. Calculate the nominal rate of interest for each bond
4. If an investor is concerned about interest rate risk, which bond will you recommend to the investor? Why?
5. Which bond is subjected to greater default risk? Why

QUESTION 3

1. Define the following terms:

(a) Corporate Bond

(b) Bond indenture

(c) Bond coupon rate

(d) Trustee

ii) Discuss the three major components of Risk Premium.

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