Question

In: Finance

1) The risk free rate on treasury bills is 2.40%. Inflation is 1.3%. What is the...

1)

The risk free rate on treasury bills is 2.40%. Inflation is 1.3%. What is the real rate of return on treasury bills?

Meaning of what is the "real rate of return" ?

If investor saw calculated number two from above, would he be pleased or not?

2)

The nominal return on treasury bonds is 2.7%, the maturity risk premium is 0.2%. Real return can earn 0.3%.

What is the inflation premium?

Why is there maturity risk premium on US treasury bonds vs. bills?

Expert Solution

1)

Nominal Risk free rate = 2.40%

Inflation rate = 1.3%

Real rate of return = (1+nominal rate)/(1+ inflation ) -1

= (1+2.4%)/(1+1.3%) -1 = 1.085%

The investor would not be pleased looking at the above numbers as the nominal figures would have tricked him/her into believing that it is the real rate.

2)

Nominal return on Treasury bonds = 2.7%

Real risk free rate = 0.3%

Maturity risk premium = 0.2%

Nominal return = Real risk free rate + Inflation premium + Maturity risk premium

Inflation premium = 2.7%-(0.3%+ 0.2%) = 2.2%

jeff jeffy answered 2 years ago

1) You are considering investing money in Treasury bills and wondering what the real risk-free rate...

1) You are considering investing money in Treasury bills and wondering what the real risk-free rate of interest is. Currently, Treasury bills are yielding 4.5 % and the future inflation rate is expected to be 2.3 % per year. Ignoring the cross product between the real rate of interest and the inflation rate, what is the real risk-free rate of interest? 2)The CFO of your firm has asked you for an approximate answer to this question: What was the increase...

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.

AMZN HD WMT Risk-Free Rate 2.40% 2.40% 2.40% Market Risk Premium 8.00% 8.00% 8.00% Beta 1.45...

AMZN HD WMT Risk-Free Rate 2.40% 2.40% 2.40% Market Risk Premium 8.00% 8.00% 8.00% Beta 1.45 1.15 0.40 Long-term Bond Yield 3.70% 3.85% 3.55% Average Tax Rate 38% 37% 32% MV Debt Capital $17,495 $27,141 $52,829 MV Equity Capital $355,438 $164,784 $214,341 WACC compute the WACC for each of the three companies (Amazon, Walmart and Home Depot). You will need to compute the cost of debt capital and the cost of equity capital from the information provided. Determine the weighted...

Treasury bills are currently paying 7 percent and the inflation rate is 2.9 percent. What is...

Treasury bills are currently paying 7 percent and the inflation rate is 2.9 percent. What is the approximate real rate of interest? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Approximate real rate % What is the exact real rate? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Exact real rate %

Treasury bills are currently paying 6.17 percent and the inflation rate is 4.36 percent. What is...

Treasury bills are currently paying 6.17 percent and the inflation rate is 4.36 percent. What is the real rate of interest?

Stocks are a risky investment. Treasury bills are highly liquid and risk free investment whose interest...

Stocks are a risky investment. Treasury bills are highly liquid and risk free investment whose interest income is not subject to state income taxes. Stocks have significantly outperformed Treasury Bills over the long term. In light of these higher returns, which best explains why an individual would invest in Treasury Bills vs. Stocks? A. US Treasury Bills are highly liquid; exempt from state and local taxes; and have lower return than stocks B. Preference for a very low risk investment...

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...

A given firm has a beta value of 1.3, the risk-free rate is 3% and the...

A given firm has a beta value of 1.3, the risk-free rate is 3% and the market risk premium is 5.5%. What is the required return for this stock? Select one: 9.55% 10.15% 11.05% 5.25% 6.25%

Treadwater stock has a beta of 1.3. The risk-free rate of return is 3.5% and the...

Treadwater stock has a beta of 1.3. The risk-free rate of return is 3.5% and the market risk premium is 4%. Treadwater stock is a zero growth stock with a dividend of $3 per share. a) What is the required rate of return on Treadwater stock? b) What is the current price of Treadwater stock? c) Suddenly, because of severe decline in the economy caused by the coronavirus and the disruption in Treadwater’s supply chain, the beta of Treadwater increases...

A. The real risk-free rate is 2.0% and inflation is expected to be 3.25% for the...

A. The real risk-free rate is 2.0% and inflation is expected to be 3.25% for the next 2 years. A 2-year Treasury security yields 6.05%. What is the maturity risk premium for the 2-year security? Round your answer to one decimal place. % B. An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. A...