### 3. Calculating Interest RatesThe real risk-free rate ($r^*$) is 2.8% and is expected to remain constant. Inflation is expected to be 5% per year for each of the next two years and 4% 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. Bond Yield Question**Smith and Carter Inc. issues thirteen-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.- 9.50%- 8.30%- 8.95%- 5.35%---**Interest Rate Determinants Question**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 an AAA-rated bond will be lower than the yield on an AA-rated bond.- The yield on U.S. Treasury securities always remains static.

Given, Risk Free Rate = 0.028 DRP = 0.80% = 0.008 LP = 0.55% = 0.0055

Answered: Smith and Carter Inc. issues…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 1.50 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real risk-free rate = 0.50% Default risk premium = 1.40% Liquidity risk premium = 1.00% Maturity risk premium = 2.00% a. What is the inflation premium? b. What is the fair interest rate on Moore Corporation 30-year bonds? Note: Round your percentage answers to 2 decimal places (ie., 0.1234 should be entered as 12.34). Expected inflation premium Fair interest rate
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