he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 3% per year for each of the next four years and 2% 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 Dare Satellite Corp.’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%   1. Dare Satellite Corp. 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.   A. 6.98%   B. 5.75%   C. 8.08%   D. 7.03%     2. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?   A. An AAA-rated bond has less default risk than a BB-rated bond.   B. The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond.

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
icon
Related questions
Question
he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 3% per year for each of the next four years and 2% 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 Dare Satellite Corp.’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%
 
1. Dare Satellite Corp. 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.
 
A. 6.98%
 
B. 5.75%
 
C. 8.08%
 
D. 7.03%
 
 
2. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?
 
A. An AAA-rated bond has less default risk than a BB-rated bond.
 
B. The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond.
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 8 steps

Blurred answer
Knowledge Booster
Treasury Market
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education