b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP Io.01(t-1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.2%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRR U.S. Treasury AAA corporate AA corporate A corporate Rate 0.83% 0.93 1.27 1.71 Corporate Bond Yield Spread DRP+ LP What yield would you predict for each of these two investments? Round your answers to three decimal places. 12-year Treasury yield: 7-year Corporate yield: 184.7 % 0.10% 0.44 0.88 %

b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP Io.01(t-1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.2%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRR U.S. Treasury AAA corporate AA corporate A corporate Rate 0.83% 0.93 1.27 1.71 Corporate Bond Yield Spread DRP+ LP What yield would you predict for each of these two investments? Round your answers to three decimal places. 12-year Treasury yield: 7-year Corporate yield: 184.7 % 0.10% 0.44 0.88 %

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 4% per year for each of the next two years and 3% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Smith and Carter Inc.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Smith and Carter Inc. issues 10-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 7.35% 7.70% 8.25% 5.05% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on a AAA-rated bond will be higher…
An investor in Treasury securities expects inflation to be 2.0% in Year 1, 2.7% in Year 2, and 3.55% each year thereafter. Assume that the real risk-free rate is 2.35% and that this rate will remain constant. Three-year Treasury securities yield 5.20%, while 5-year Treasury securities yield 6.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 - MRP3? Do not round intermediate calculations. Round your answer to two decimal places
The real risk-free rate is 2.70%, inflation is expected to be 3.45% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, i.e., if averaging is required, use the arithmetic average, what is the equilibrium rate of return on a 1-year Treasury bond? Please explain process and show calculations
Assume that the real, risk-free rate of interest is expected to be constant over time at 3 percent, and that the annual yield on a 6-year corporate bond is 8.00 percent, while the annual yield on a 10-year corporate bond is 7.75 percent: you may assume that the default risk and liquidity premium are the same for both bonds. Also assume that the maturity risk premium for all securities can be estimated as MRP, (0.1%) *(t-1), where t is the number of periods until maturity. Finally assume that inflation is expected to be constant at 3 percent for Years 1-6, and then constant at some rate for Years 7-10 (4 years). Given this information, determine what the market must anticipate the average annual rate of inflation will be for Years 7-10. 2.583% O 1979% 2.281% 1.375 % O 1.677 % 4
3. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next two years and 6% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Smith and Carter Inc.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Smith and Carter Inc. issues 7-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 11.54% 10.94% 10.49% 5.25% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? In…
b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, AA-rated corporate band. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0.03 (t-1) %. The liquidity premium (LP) for the corporate bond is estimated to be 0.2%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRP. Rate 0.83% 1.03 1.35 1.73 Corporate Bond Yield Spread = DRP + LP U.S. Treasury AAA corporate 0.20% AA corporate 0.52 A corporate 0.90 What yield would you predict for each of these two investments? Round your answers to three decimal places, 12-year Treasury yield: 7-year Corporate yield: % %
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The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next four years and 6% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Harrington Horticulture Co.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Harrington Horticulture Co. issues seven-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. A.) 10.77% B.) 11.22% C.) 11.82% D.) 5.25% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? A.) The yield on an AAA-rated bond will be higher than the yield on a…
An investor in Treasury securities expects inflation to be 2.2% in Year 1, 2.7% in Year 2, and 3.65% each year thereafter. Assume that the real risk-free rate is 2.45% and that this rate will remain constant. Three-year Treasury securities yield 5.50%, while 5-year Treasury securities yield 7.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 - MRP3? Do not round intermediate calculations. Round your answer to two decimal places.
9. Interest Rate Risk. Suppose that you are a fixed income portfolio manager at Bourbon Street Capital. You have the following bonds issued by Royal, Inc. and Chartres, LLC in your portfolio and you want to understand the risk profile of your portfolio. Given that both bonds pay semiannual coupons, answer the following questions. (Remember to convert your answer to units of full years.) Coupon Yield to maturity Maturity (years) Royal, Inc. Chartres, LLC. Bond A Bond B 9% 8% 5 $100.00 $104.055 8% 8% 2 Par $100.00 Price $100.00 (a) What is the DV01 (at current prices) for bonds A and B? (b) What are the Macaulay Durations (at current prices) for the two bonds? (c) What are the modified durations for the two bonds? (d) What is the convexity of the two bonds?
Assume that the Pure Expectations Theory of the term structure is correct. Also assume that the interest rate today on a 9-year security is 6.40%, while the interest rate today on a 15-year security is 8.00%. Finally assume that the interest rate on a 3-year security to be bought at Year 9 and held over Years 10, 11, and 12 is 6.80%. Given this information, determine the average annual return that investors today must expect that they will receive from investing in a 3-year security in 12 Years (that is, buying the security at Year 12 and holding it over Years 13, 14, and 15). O 13.00% O 12.50% 13.50% O 12.00% O 14.00%
9. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 8% per year for each of the next two years and 7% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Gauge Imports Inc.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Gauge Imports Inc. issues 12-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 11.87% 11.32% 5.25% 12.42% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on a AAA-rated bond will be lower than the yield on a AA-rated bond. A…

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