hope everyone is enjoying the beautiful weather stuck inside reading this mind-numbing material: 1)does anyone know why the inflation risk premium wasn’t added to each of the spreads to get the average risk spread? The way the solution is set up, it’s like they aren’t treating inflation like the rest of the spreads (i.e. they break it out from the rest of them), even though the formula would imply that they are also a type of risk premium, just like the other 4 (default, liquidity, maturity, and tax). is it because inflation affects all of them (including the 10-year treasury bond), so it just cancels out everywhere? 2) where does the 1% come from that I’m subtracting the expected total risk premiums of the three securities from? It’s probably from the spread of the 10-year over the 1-year, but I don’t understand the logic behind that. thanks!
use the serach function-been discussed.
the only thread i could find related to this question was this: http://www.analystforum.com/phorums/read.php?13,1106354,1106354#msg-1106354 can you give me the link to the thread that explains my questions? I tried searching on a bunch of different words, but to no avail…
this question is confusing, and i’ve spent too much time trying to understand it. i’m moving on
The term “risk premium” is often used to refer to the total premium above the nominal default-risk-free interest rate (quoted from CFAI textbook Vol.III. P.40) So. Inflation has been already included in the nominal risk free rate. Spread/Risk premium = Total return - Nominal Risk free rate The question said He will only make the added investment provided that the expected spread/premium of the equally weighted investment is at least 0.5 percent over the 10-year Treasury bond. Spread of 10 year T-bond = 1% (maturity premium over 1 yr T-note) As the portfolio spread is 1.22% which is only 0.22% (NOT 5%) over spread of 10 year T-bond => Will not make the investment. Hope it helps.
taketwo Wrote: ------------------------------------------------------- > the only thread i could find related to this > question was this: > > http://www.analystforum.com/phorums/read.php?13,11 > 06354,1106354#msg-1106354 > > can you give me the link to the thread that > explains my questions? I tried searching on a > bunch of different words, but to no avail… I could not find it too. Sorry about that
B_C Wrote: ------------------------------------------------------- > The term “risk premium” is often used to refer to > the total premium above the nominal > default-risk-free interest rate (quoted from CFAI > textbook Vol.III. P.40) > > So. Inflation has been already included in the > nominal risk free rate. > > Spread/Risk premium = Total return - Nominal Risk > free rate > > The question said He will only make the added > investment provided that the expected > spread/premium of the equally weighted investment > is at least 0.5 percent over the 10-year Treasury > bond. > > Spread of 10 year T-bond = 1% (maturity premium > over 1 yr T-note) > As the portfolio spread is 1.22% which is only > 0.22% (NOT 5%) over spread of 10 year T-bond => > Will not make the investment. > > Hope it helps. I got to the part of calculating 1.22, but then why you deduct 1.00 from it? Aren’t all spreads accounted for in 1.22?