Interest Rate Determination and Yield Curves-98b765

Interest Rate Determination and Yield Curves b. Finding the yield for each of the two investments Real risk-free rate 3% Expected inflation 3% for the next 2 years Expected inflation 4% for the following 4 years Expected inflation thereafter 5% Maturity risk premium = 0.02% ×(t - 1) Liquidity premium 0.3% Maturity of treasury bond 12 years Maturity of corporate bond 7 years Corporate bond rating A 12-year Treasury Bond Formulas Real risk-free rate 3.000% =C4 Inflation premium 4.333% =(E5*C5+E6*C6+(C10-E5-E6)*C7)/C10 Maturity risk premium 0.220% =C8*(C10-1) 12-year Treasury yield 7.553% =SUM(C15:C17) Rating DRP + LP AAA 0.10% AA 0.52% A 0.96% 7-year Corporate Bond Real risk-free rate 3.000% =C4 Inflation premium 3.857% =(E5*C5+E6*C6+(C11-E5-E6)*C7)/C11 Maturity risk premium 0.120% =C8*(C11-1) Liquidity premium 0.300% =C9 Default risk premium 0.660% =VLOOKUP(C12,A21:B23,2,0)-C9 7-year corporate yield 7.937% =SUM(C26:C30) с. Constructing a graph of the yield curve Years to Maturity Yield 1 5.32% 2 5.42% 3 5.57% 4 5.62% 5 5.55% 10 5.65% 20 6.11% 30 5.81% A B C D E F 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46

d. Calculating yields and then constructing a new yield curve graph that shows both the Treasury and the corporate bonds Years Spread LP DRP 1 5.32% 6.28% 0.96% 0.30% 0.66% 2 5.42% 6.38% 0.96% 0.30% 0.66% 3 5.57% 6.53% 0.96% 0.30% 0.66% 4 5.62% 6.58% 0.96% 0.30% 0.66% 5 5.55% 6.51% 0.96% 0.30% 0.66% 10 5.65% 6.61% 0.96% 0.30% 0.66% 20 6.11% 7.07% 0.96% 0.30% 0.66% 30 5.81% 6.77% 0.96% 0.30% 0.66% Treasury yield A-Corporate yield A B C D E F 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83

Formulas Years 1 5.32% 2 5.42% 3 5.57% 4 5.62% 5 5.55% 10 5.65% 20 6.11% 30 5.81% Treasury yield G H I 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83

B36)-1 +B40)^5)^(1/5)-1 +B41)^10)^(1/10)-1 +B42)^20)^(1/10)-1 G H I 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100