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QUESTION 8 Part A: Assume that interest rates on 20-year Treasury and corporate bonds are as...

QUESTION 8

Part A: Assume that interest rates on 20-year Treasury and corporate bonds are as follows:

T-bond = 7.72%

AAA = 8.72%

A = 9.64%

BBB = 10.18%

The differences in these rates were probably caused primarily by:

a. Real risk-free rate differences.

b. Maturity risk differences.

c. Default and liquidity risk differences.

d. Inflation differences.

e. Tax effects.

Part B: Which of the following is incorrect?

a. the currency’s purchasing power is reduced by a rate known as the inflation rate. Inflation makes real dollars less valuable in the future and is factored into determining the nominal interest rate.

b. Default risk premium is high is the corporate entity has a low credit rating

c. Treasury debt is most liquid debt and therefore requires no liquidity risk premium.

d. Corporate debt is the most liquid debt and therefore requires some liquidity risk premium

e. The longer the maturity of the bond is, the larger the maturity risk premium.

Expert Solution

Answer:

Part A:

The default risk is the risk of settlement and liquidity risk is the default in coupon payments. As the risk that present should be remunerated by the premium.

Hence the correct answer is default and liquidity differences.

Part B

The expected inflation rate in the market anticipates increasing the aggregate price in the market.

Maturity risk premiums are intended to reimburse investors for captivating on the risk of holding bonds over a extended timer period until its maturity.

Hence the correct answer is Statement A and Statement E.

Answer:

Part A:

The default risk is the risk of settlement and liquidity risk is the default in coupon payments. As the risk that present should be remunerated by the premium.

Hence the correct answer is default and liquidity differences.

Part B

The expected inflation rate in the market anticipates increasing the aggregate price in the market.

Maturity risk premiums are intended to reimburse investors for captivating on the risk of holding bonds over a extended timer period until its maturity.

Hence the correct answer is Statement A and Statement E.

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jeff jeffy answered 2 years ago

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