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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 on a 4-year corporate bond.

Expert Solution

A)average inflation over 4 years : [1.5+2+3+3 ]/4

= 9.5/4

= 2.375% (rounded to 2.38%)

b) yield on a 4-year T-bond. =Risk free rate+ IP +MRP

= 1+ 2.38+ (-.6)

=1+2.38 -.6

= 2.78%

**MRP = .2*(1-4)%

= .2* -3

= -.6%

c) yield on a 4-year corporate bond. =Risk free rate+ IP +MRP + DRP+LP

= 1+2.38 +(-.6) +.9+.5

=1+ 2.38 -.6 +.9+ .5

= 4.18%

jeff jeffy answered 1 year ago

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