YIELD CURVES Suppose the inflation rate is expected to be 7% next year, 5% the following year, and 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1 year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5 year or longer term T-bonds. a. Calculate the interest rate 1-,2-,3-,4-,5-,10- and 20-year Treasury Securities and plot the yield curve. b. Suppose a AAA-rated company (which is the highest bond rating a firm can have) had bonds with the same maturities as the Treasury bonds. Estimate and plot what you believe a AAA-rated company’s yield curve would look like on the same graph with the treasury bond yield curve. (Hint: think about the default risk premium on its long term versus in short-term bonds) c. On the same graph, plot the approximate yield curve of a much: riskier lower rated company with a much higher risk a defaulting on its bonds.
YIELD CURVES Suppose the inflation rate is expected to be 7% next year, 5% the following year, and 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1 year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5 year or longer term T-bonds.
a. Calculate the interest rate 1-,2-,3-,4-,5-,10- and 20-year Treasury Securities and plot the yield curve.
b. Suppose a AAA-rated company (which is the highest bond rating a firm can have) had bonds with the same maturities as the Treasury bonds. Estimate and plot what you believe a AAA-rated company’s yield curve would look like on the same graph with the treasury bond yield curve. (Hint: think about the default risk premium on its long term versus in short-term bonds)
c. On the same graph, plot the approximate yield curve of a much: riskier lower rated company with a much higher risk a defaulting on its bonds.
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