Question

In: Finance

Assume that the real risk-free rate, r*, is 2% and that inflation is expected to be 7% in Year 1, 6% in Year 2, and 3% thereafter.

Problem 4-19
Maturity Risk Premiums

Assume that the real risk-free rate, r*, is 2% and that inflation is expected to be 7% in Year 1, 6% in Year 2, and 3% thereafter. Assume also that all Treasury securities are highly liquid and free of default risk. If 2-year and 5-year Treasury notes both yield 10%, what is the difference in the maturity risk premiums (MRPs) on the two notes; that is, what is MRP₅minus MRP₂? Round your answer to two decimal places.

%

Expert Solution

r_t = 4 % + IP_t +MRP_t

IP_S = ( Each year inflation ) / Number of years

= (7% +6% +3%+3%+3%) / 5

= 4.4%

IP₂ = (7% +6% ) / 2

= 6.5 %

Substitute the equation ,

r₅ = 2 % +4.4 % +MRP = 10 %

r₂ = 2% +6.5 % +MRP = 10 %

Now let's Solve MRP₅ , then find the defference

MRP₅ =10 % - 6.4 % = 3.6 %

MRP₂ = 10% - 8.5% = 1.5 %

Defference = 3.6 % - 1.5 %

=2.1 %

jeff jeffy answered 2 years ago

The real risk-free rate of interest is 3%. Inflation is expected to be 2% this year...

The real risk-free rate of interest is 3%. Inflation is expected to be 2% this year and 3% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? (If financial calculator is used show those computations and show ALL work)

The real risk-free rate is 3%, and inflation is expected to be 2% for the next...

The real risk-free rate is 3%, and inflation is expected to be 2% for the next 2 years. A 2-year Treasury security yields 6.1%. What is the maturity risk premium for the 2-year security? Round your answer to one decimal place. %

The real risk-free rate, r*, is 3.1%. Inflation is expected to average 2.95% a year for...

The real risk-free rate, r*, is 3.1%. Inflation is expected to average 2.95% a year for the next 4 years, after which time inflation is expected to average 3.5% a year. Assume that there is no maturity risk premium. An 11-year corporate bond has a yield of 11.65%, which includes a liquidity premium of 0.9%. What is its default risk premium? Do not round intermediate calculations. Round your answer to two decimal places.

The real risk-free rate, r*, is 1.4%. Inflation is expected to average 1.1% a year for...

The real risk-free rate, r*, is 1.4%. Inflation is expected to average 1.1% a year for the next 4 years, after which time inflation is expected to average 3.6% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 9.0%, which includes a liquidity premium of 0.7%. What is its default risk premium? Do not round intermediate calculations. Round your answer to two decimal places. %

The real risk-free rate, r*, is 1.6%. Inflation is expected to average 1.3% a year for...

The real risk-free rate, r*, is 1.6%. Inflation is expected to average 1.3% a year for the next 4 years, after which time inflation is expected to average 4.2% a year. Assume that there is no maturity risk premium. A 10-year corporate bond has a yield of 8.4%, which includes a liquidity premium of 0.3%. What is its default risk premium? Do not round intermediate calculations. Round your answer to two decimal places.

The 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.

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 Global Satellite Corp.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):RatingDefault Risk...

The real risk-free rate is 3.5%. Inflation is expected to be 2% this year and 3.75%...

The real risk-free rate is 3.5%. Inflation is expected to be 2% this year and 3.75% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. % What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. %

3. The real risk-free rate is 3%, and inflation is expected to be 4% for the...

3. The real risk-free rate is 3%, and inflation is expected to be 4% for the next 2 years. A 2-year Treasury security yields 8.3%. What is the maturity risk premium for the 2-year security? Round your answer to one decimal place. 4. Renfro Rentals has issued bonds that have a 9% coupon rate, payable semiannually. The bonds mature in 6 years, have a face value of $1,000, and a yield to maturity of 7.5%. What is the price of...

The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected...

The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 4% per year for each of the next three years and 3% 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 Global Satellite Corp.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): AAA- 0.60% AA-...

The real risk-free rate of interest is 1%, inflation is expected to be 1.5% this year,...

The real risk-free rate of interest is 1%, inflation is expected to be 1.5% this year, 2% next year, and 3% per year for the next 5 years. The maturity risk premium is a function of time to maturity = 0.2* (1-t) %. The default risk premium on a corporate bond is 0.9%; and liquidity premium is 0.5%. a. What is the IP over the next 4 years? b. Find the yield on a 4-year T-bond. c. Find the yield...