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…
12. Suppose that 1-year bonds currently offer a nominal yield to maturity of 4% (1,0 = 0.04), otherwise comparable 2-year bonds currently offer a yield to maturity of 4.5% (12,0 = 0.045), and 3 year bonds currently offer a yield to maturity of 4.8% (13,0 = 0.048). a. Draw the current yield curve. b. Based on the Expectations Theory of Term Structure, what yield to maturity do investors expect next year's 1 year bonds to earn (i.e. - what is it,1)? c. What do investors expect the yield to be on 1 year bonds in two years (11,2 = ?)? d. What do investors expect the yield to be on 2 year bonds next year (i2,1 =?)?
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
The real risk-free rate is 2% which is projected to be constant indefinitely. The expected inflation for year 1 is 1%, for year 2 is 2%, and it will increase by 1% each year after. Liquidity Premium is 1% and the default risk premium is 2.5%. Maturity Risk premium for long-term securities is computed as estimated to be 0.5%(t - 1), where “t” is the years of maturity of the bond. The yield for an 15-year government bond is a. 17.0% b. 17.5% c. 60.0% d. 16.0%
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…
An investor in Treasury securities expects inflation to be 14,25% in Year 1, 12,20% in Year 2, 9,60%. in Year 3 and 8,00% each year thereafter. Assume that the real risk-free rate is 2,00% and that this rate will remain constant. Three-year Treasury securities yield 12,87%, while 7-year Treasury securities yield 13,47%. What is the difference in the maturity risk premiums (MRPS) on the two securities; that is, what is MRP, - MRP3?
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: % %
1.
The following data are gathered for:· The real risk-free rate is 1.25%· Inflation premium is constant at 2.50%· Default risk premium is 5%· Liquidity risk premium is 0.50% What is the quoted rate on a short-term government security?
Suppose the real risk-free rate is 2.5%, the average future inflation rate is 2.3%, a maturity premium of 0.07% per year to maturity applies, i.e., MRP = 0.07% (t), where t is the years to maturity. Suppose also that a liquidity premium of 1% and a default risk premium of 0.7% applies to A-rated corporate bonds. How much higher would the rate of return be on a 7-year A-rated corporate bond than on a 5-year Treasury bond. Here we assume that the pure expectations theory is NOT valid. O 1.84% O 1.64% O 1.44% O 1.24% 1.04%

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