3. Calculating interest ratesThe 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 five 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 Pandar Corp.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):RatingDefault Risk PremiumU.S. Treasury—AAA0.60%AA0.80%A1.05%BBB1.45% A. Pandar Corp. 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. 12.46% 11.86% 11.91% 4.75% B. 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 U.S. Treasury securities always remains static. An AAA-rated bond has less default risk than a BB-rated bond.

Yield on AA-rated bonds is calculated as follows: Yield=Real risk free rate+Average Inflation…

Answered: The real risk-free rate (r*) is 2.8%…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter4: Bond Valuation

Section: Chapter Questions

Problem 19P

See similar textbooks

3. 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 five 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 Pandar Corp.’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%

A. Pandar Corp. 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.

12.46%

11.86%

11.91%

4.75%

B. 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 U.S. Treasury securities always remains static.

An AAA-rated bond has less default risk than a BB-rated bond.

Expert Solution

Trending now

This is a popular solution!

Step by step

Solved in 2 steps

SEE SOLUTION Check out a sample Q&A here

Knowledge Booster

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.