Question

An analyst evaluating securities has obtained the following information. The real rate of interest is 2.9% and is expected to remain constant for the next 5 years. Inflation is expected to be 2.6% next year, 3.6% the following year, 4.6% the third year, and 5.6% every year thereafter. The maturity risk premium is estimated to be 0.1 × (t – 1)%, where t = number of years to maturity. The liquidity premium on relevant 5-year securities is 0.5% and the default risk premium on relevant 5-year securities is 1%

a. What is the yield on a 1-year T-bill? Do not round intermediate calculations. Round your answer to one decimal place.

  b. What is the yield on a 5-year T-bond? Do not round intermediate calculations. Round your answer to one decimal place.

   c. What is the yield on a 5-year corporate bond? Do not round intermediate calculations. Round your answer to one decimal place.

Answer 1

a. What is the yield on a 1-year T-bill? Do not round intermediate calculations. Round your answer to one decimal place.

yield on a 1-year T-bill = Real Rate + Inflation Premium for year 1

yield on a 1-year T-bill = 2.90% + 2.60%

Yield on a 1-year T-bill = 5.5%

b. What is the yield on a 5-year T-bond? Do not round intermediate calculations. Round your answer to one decimal place.

yield on a 5-year T-Bond = Real Rate + Average Inflation Premium for 5 years + Maturity risk premium

yield on a 5-year T-Bond = 2.90% + (2.60%+3.60%+4.60%+5.60%+5.60%)/5] + 0.10*(5-1)%

yield on a 5-year T-Bond = 2.90% + 4.40% + 0.40%

yield on a 5-year T-Bond = 7.7%

c. What is the yield on a 5-year corporate bond? Do not round intermediate calculations. Round your answer to one decimal place.

Yield of corporate bond = Real Rate + Average Inflation Premium for 5 years + Maturity risk premium + liquidity premium + default risk premium

Yield of corporate bond = 2.90% + 4.40% + 0.40% + 0.50%+1%

Yield of corporate bond = 9.2%