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1. You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.7%. Your...

1. You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.7%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

  • Inflation premium = 2.50%
  • Liquidity premium = 0.7%
  • Maturity risk premium = 1.85%
  • Default risk premium = 2.00%

On the basis of these data, what is the real risk-free rate of return? Round your answer to two decimal places.

2. The real risk-free rate is 2.25%. Inflation is expected to be 1.50% this year and 5.00% 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. A Treasury bond that matures in 10 years has a yield of 5.50%. A 10-year corporate bond has a yield of 7.25%. Assume that the liquidity premium on the corporate bond is 0.55%. What is the default risk premium on the corporate bond? Round your answer to two decimal places.

____%

4. The real risk-free rate is 2.0% and inflation is expected to be 2.75% for the next 2 years. A 2-year Treasury security yields 5.65%. What is the maturity risk premium for the 2-year security? Round your answer to one decimal place.

____%

Solutions

Expert Solution

Answer to Question 1:

Yield on T-Bills = Real Risk-free Rate + Inflation Premium
5.70% = Real Risk-free Rate + 2.50%
Real Risk-free Rate = 3.20%

Answer to Question 2:

Part a:

Inflation Premium = Average Inflation Rate over 2 years
Inflation Premium = [1.50% + 5.00%] / 2
Inflation Premium = 6.50% / 2
Inflation Premium = 3.25%

Yield on 2-Year Treasury Securities = Real Risk-free Rate + Inflation Premium + Maturity Risk Premium
Yield on 2-Year Treasury Securities = 2.25% + 3.25% + 0.00%
Yield on 2-Year Treasury Securities = 5.50%

Part b:

Inflation Premium = Average Inflation Rate over 3 years
Inflation Premium = [1.50% + 5.00% + 5.00%] / 3
Inflation Premium = 11.50% / 3
Inflation Premium = 3.83%

Yield on 3-Year Treasury Securities = Real Risk-free Rate + Inflation Premium + Maturity Risk Premium
Yield on 3-Year Treasury Securities = 2.25% + 3.83% + 0.00%
Yield on 3-Year Treasury Securities = 6.08%

jeff jeffy answered 1 year ago
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