he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next two years and 6% 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 Smith and Carter Inc.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Smith and Carter Inc. issues 7-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 11.54% 10.94% 10.49% 5.25% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity. A BBB-rated bond has a lower default risk premium
he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next two years and 6% 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 Smith and Carter Inc.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Smith and Carter Inc. issues 7-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 11.54% 10.94% 10.49% 5.25% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity. A BBB-rated bond has a lower default risk premium
Chapter8: Analysis Of Risk And Return
Section: Chapter Questions
Problem 10P
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3. Calculating interest rates
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next two years and 6% 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 Smith and Carter Inc.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):
Rating
|
Default Risk Premium
|
---|---|
U.S. Treasury | — |
AAA | 0.60% |
AA | 0.80% |
A | 1.05% |
BBB | 1.45% |
Smith and Carter Inc. issues 7-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average.
11.54%
10.94%
10.49%
5.25%
Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?
In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity.
A BBB-rated bond has a lower default risk premium as compared to an AAA-rated bond.
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