Problem 2 Consider the yield curve above. Suppose the (expected) one-year interest rates in periods 1, 2, 3, and 4 are 1%, 2%, 2%, 3%, respectively. Find liquidity premiums for 1-,2-,3-, and 4-year bonds. Show your work.

Problem 2 Consider the yield curve above. Suppose the (expected) one-year interest rates in periods 1, 2, 3, and 4 are 1%, 2%, 2%, 3%, respectively. Find liquidity premiums for 1-,2-,3-, and 4-year bonds. Show your work.

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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A plot of the yields on bonds with different terms to maturity but the same risk, liquidity, and tax considerations is known as O A. a yield curve. B. a risk-structure curve. OC. a term-structure curve. 5- O D. an interest-rate curve. Suppose people expect the interest rate on one-year bonds for each of the next four years to be 3%, 6%, 5%, and 6%. If the expectations theory of the term structure of interest rates is correct, then the implied interest rate on bonds with a maturity of four years is nearest whole number). %. (Round your response to the 2- Refer to the figure on your right. Suppose the expected interest rates on one-year bonds for each of the next four years are 4%, 5%, 6%, and 7%, respectively. 1. 1.) Use the line drawing tool (once) to plot the yield curve generated. 3 Term to Maturity in Years 2.) Use the point drawing tool to locate the interest rates on the next four years. 5. 3- Interest Rate .....
If the interest rates on 1-, 5-, 20-, and 30-year bonds are (respectively)4%, 5%, 6%, and 7%, then how would you describe the yield curve?How would you describe it if the rates were reversed?
Suppose you are given the following information about the default-free, coupon-paying yield curve: Maturity (years) Coupon rate (annual payment) YTM 1 0.00% 2.587% a. Use arbitrage to determine the yield to maturity of a two-year zero-coupon bond. b. What is the zero-coupon yield curve for years 1 through 4? Note: Assume annual compounding. 2 11.00% 4.008% a. Use arbitrage to determine the yield to maturity of a two-year zero-coupon bond. The yield to maturity of a two-year, zero-coupon bond is %. (Round to two decimal places.) b. What is the zero-coupon yield curve for years 1 through 4? The yield to maturity for the three-year and four-year zero-coupon bond is found in the same manner as the two-year zero-coupon bond. The yield to maturity on the three-year, zero-coupon bond is %. (Round to two decimal places.) The yield to maturity on the four-year, zero-coupon bond is %. (Round to two decimal places.) Which graph best depicts the yield curve of the zero-coupon bonds? (Select the…
Assume that thr nominal interest rate is 14%, the risk premium is 4% and real interest rate is 3%, find the inflation rate and the risk free interest rate.
The value of any financial asset is the present ✓ value of the cash flows the asset is expected to produce. For a bond with fixed annual coupons, its value is equal to the present value of all its annual interest payments and its maturity value as shown in the equation below: Bond's value = VB: Int. Int. (1+ra)² (1+ra)² N + ·+...+ Int. M + (1+ra)* (1+ra) Int. M (1+ra) (1+ra)N + We could use the valuation equation shown above to solve for a bond's value; however, it is more efficient to use a financial calculator. Simply enter N as years to maturity, I/YR as the going annual interest rate, PMT as the annual coupon payment (calculated as the annual coupon interest rate times the face value of the bond), and FV as the stated maturity value. Once those inputs are entered in your financial calculator, you can solve for PV, the value of the bond. Remember that the signs for PMT and FV should be the same, so PV will have an opposite sign. Typically, you would enter PMT and FV as positive…
Unlike the coupon interest rate, which is fixed, a bond's yield varies from day to day depending on market conditions. To be most useful, it should give us an estimate of the rate of return an investor would earn if that investor purchased the bond today and held it for its remaining life. There are three different yield calculations: Current yield, yield to maturity, and yield to call. A bond's current yield is calculated as the annual interest payment divided by the current price. Unlike the yield to maturity or the yield to call, it does not represent the actual return that investors should expect because it does not account for the capital gain or loss that will be realized if the bond is held until it matures or is called. This yield was popular before calculators and computers came along because it was easy to calculate; however, because it can be misleading, the yield to maturity and yield to call are more relevant. The yield to maturity (YTM) is the rate of return earned on a…
Assume the Liquidity Premium Theory of the Term Structure of Interest Rates holds. The WSJ quotes 0.25% annual yield on a one-year T-note and 0.5% annual yield on a two-year T-note. Suppose the annual yield on a one-year T-note is expected to stay at 0.25% over the next 2 years. What must be the liquidity premium on a two-year T-note?
Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, AA-rated corporate bond. The current real risk-free rate is 3%, 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 = 0.02(t - 1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.3%. 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. Corporate Bond Yield Rate Spread = DRP + LP U.S. Treasury 0.73 % — AAA corporate 0.93 0.20 % AA corporate 1.33 0.60 A corporate 1.75 1.02 What yield would you predict for each of these two investments? Round your answers to three decimal places. 12-year Treasury yield: 6.553%----->correct 7-year Corporate yield: ? %…
Consider the zero coupon Treasury bond yield curve. Suppose a 1 year bond has a yield of 2.13%. The yield curve slopes downwards between maturities of 1 year and 3 years, and then slopes upwards. Which of the following must be true? Group of answer choices A) The yield of a zero coupon bond with maturity 5 years is higher than 2.13%. B) A 1 year positive coupon bond must have a lower price than the zero coupon bond with the same maturity. C) Bond purchasers believe the Fed will decrease rates in the short run, and then increase them in the long run. D) The economy will be in a recession within 2 years. E) C and D.
As bonds approach their maturity dates, www A. prices will approach their par values. OB. the risk of a call will increase. OC. premiums or discounts will increase. O D. the bonds' prices will become more sensitive to changes in interest rates.
EXPECTATIONS THEORY Assume that the real risk-free rate is 2% and that the risk premium is zero. If a 1-year Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2? Calculate this yield using a geometric average. What inflation rate is expected during Year 2? Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2. 6-15 maturity
A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Suppose the bond issued by Logan Inc. has 5-year maturity with coupon of 12%. 4.1. If the yield to maturity is 10%, compute the bond value. Compute the modified duration of this bond. Use the modified duration to estimate the change in price if the interest rate decreases by 0.50%. 4.2. 4.3.

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