Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN: 9781337395083
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
expand_more
expand_more
format_list_bulleted
Videos
Question
Chapter 4, Problem 19P
Summary Introduction
To determine: The difference between
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Assume that the real risk-free rate, r*, is 3% and that inflation is expectedto be 8% in Year 1, 5% in Year 2, and 4% thereafter. Assume also that allTreasury securities are highly liquid and free of default risk. If 2-year and5-year Treasury notes both yield 10%, what is the difference in the maturityrisk premiums (MRPs) on the two notes; that is, what is MRP5minus MRP2?
Suppose the real risk-free rate is 2.80%, the average future inflation rate is 2.30%, a maturity premium of 0.25% per year to maturity applies, i.e., MRP = 0.25%(t), where t is the number of years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 2.50% applies to A-rated corporate bonds. What is the difference in the yields on a 5-year A-rated corporate bond and on a 10-year Treasury bond? Here we assume that the pure expectations theory is NOT valid, and disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 4.25 p.p.
b. 2.25 p.p.
c. 4.19 p.p.
d. 3.00 p.p.
e. 1.75 p.p.
Please explain process and show calculations
Assume that the real risk-free rate is 2% and the average annual expected inflation rate is 4%. The DRP and LP for Bond A are each 2%, and the applicable MRP is 3%.
What is Bond A's interest rate?
Chapter 4 Solutions
Intermediate Financial Management (MindTap Course List)
Ch. 4 - Short-term interest rates are more volatile than...Ch. 4 - The rate of return on a bond held to its maturity...Ch. 4 - If you buy a callable bond and interest rates...Ch. 4 - A sinking fund can be set up in one of two ways....Ch. 4 - Prob. 1PCh. 4 - Prob. 2PCh. 4 - Current Yield for Annual Payments Heath Food...Ch. 4 - Determinant of Interest Rates
The real risk-free...Ch. 4 - Default Risk Premium A Treasury bond that matures...Ch. 4 - Prob. 6P
Ch. 4 - Bond Valuation with Semiannual Payments
Renfro...Ch. 4 - Prob. 8PCh. 4 - Bond Valuation and Interest Rate Risk The Garraty...Ch. 4 - Prob. 10PCh. 4 - Prob. 11PCh. 4 - Bond Yields and Rates of Return A 10-year, 12%...Ch. 4 - Yield to Maturity and Current Yield You just...Ch. 4 - Current Yield with Semiannual Payments
A bond that...Ch. 4 - Prob. 15PCh. 4 - Interest Rate Sensitivity
A bond trader purchased...Ch. 4 - Bond Value as Maturity Approaches An investor has...Ch. 4 - Prob. 18PCh. 4 - Prob. 19PCh. 4 - Prob. 20PCh. 4 - Bond Valuation and Changes in Maturity and...Ch. 4 - Yield to Maturity and Yield to Call
Arnot...Ch. 4 - Prob. 23PCh. 4 - Prob. 1MCCh. 4 - Prob. 2MCCh. 4 - How does one determine the value of any asset...Ch. 4 - Prob. 4MCCh. 4 - What would be the value of the bond described in...Ch. 4 - Suppose a 10-year, 10% semiannual coupon bond with...Ch. 4 - Prob. 9MCCh. 4 - Prob. 10MCCh. 4 - Prob. 11MCCh. 4 - Prob. 12MCCh. 4 - Prob. 14MCCh. 4 - Prob. 15MCCh. 4 - Prob. 16MCCh. 4 - Prob. 17MC
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Suppose the real risk - free rate is 3.50 %, the average future inflation rate is 2.50%, a maturity premium of 0.20% per year to maturity applies, i.e., MRP = 0.20% (t), where t is the number of years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 2.70% applies to A-rated corporate bonds. What is the difference in the yields on a 5-year A - rated corporate bond and on a 10-year Treasury bond? Here we assume that the pure expectations theory is NOT valid, and disregard any cross - product terms, i.e., if averaging is required, use the arithmetic average. a. 4.90 p. p. b. 3.20 p.p. c. 4.11 p.p. d. 2.70 p.p. e. 2.20 p.p.arrow_forwardSuppose the real risk-free rate is 2.5%, the average future inflation rate is 2.3%, a maturity premium of 0.07% per year to maturity applies, i.e., MRP = 0.07% (t), where t is the years to maturity. Suppose also that a liquidity premium of 1% and a default risk premium of 0.7% applies to A-rated corporate bonds. How much higher would the rate of return be on a 7-year A-rated corporate bond than on a 5-year Treasury bond. Here we assume that the pure expectations theory is NOT valid. O 1.84% O 1.64% O 1.44% O 1.24% 1.04%arrow_forwardAssume that the real risk-free rate is 2% and that the maturityrisk premium is zero. If a 1-year Treasury bond yield is 5% and a 2-year Treasury bondyields 7%, what is the 1-year interest rate that is expected for Year 2? Calculate this yieldusing a geometric average. What inflation rate is expected during Year 2? Comment onwhy the average interest rate during the 2-year period differs from the 1-year interestrate expected for Year 2.arrow_forward
- Assume the real risk-free is 1% and the average annual expected inflation rate is 4%. The DRP and LP for bond A are each 3%, and the applicable MRP is 3%. What is Bond A's interest rate?arrow_forwardAn investor in Treasury securities expects inflation to be 2.1%in Year 1, 2.7% in Year 2, and 3.65% each year thereafter. Assume that the real risk-free rateis 1.95% and that this rate will remain constant. Three-year Treasury securities yield 5.20%,while 5-year Treasury securities yield 6.00%. What is the difference in the maturity riskpremiums (MRPs) on the two securities; that is, what is MRP5 - MRP3?arrow_forwardAn investor in Treasury securities expects inflation to be 2.1% in Year 1, 3.0% in Year 2, and 4.25% each year thereafter. Assume that the real risk-free rate is 2.25% and that this rate will remain constant. Three-year Treasury securities yield 5.20%, while 5-year Treasury securities yield 6.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 - MRP3? Do not round intermediate calculations. Round your answer to two decimal places.arrow_forward
- Assume that the real risk free rate is 3% and the average annual expected inflation rate is 5%. The DRP and LP for Bond A are each 1% and the applicable MRP is 2%. What is bond A’s interest rate?arrow_forwardAn investor in Treasury securities expects inflation to be 2.1% in Year 1, 2.7% in Year 2, and 3.65% each year thereafter. Assume that the real risk-free rate is 1.95% and that this rate will remain constant. Three-year Treasury securities yield 5.20%, while 5-year Treasury securities yield 6.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is ?arrow_forwardSuppose 2-year Treasury bonds yield 4.1%,while 1-year bonds yield 3.2%. r* is 1%, and the maturity risk premium is zero.a. Using the expectations theory, what is the yield on a 1-year bond, 1 year from now?Calculate the yield using a geometric average.b. What is the expected inflation rate in Year 1? Year 2?arrow_forward
- EXPECTATIONS THEORY Assume that the real risk-free rate is 2% and that the risk premium is zero. If a 1-year Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2? Calculate this yield using a geometric average. What inflation rate is expected during Year 2? Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2. 6-15 maturityarrow_forwardSuppose that y is the yield on a perpetual government bond that pays interest at the rate of $1 per annum. Assume that y is expressed with simply com- pounding, that interest is paid annually on the bond, and that y follows the process dy = a(y0 −y)dt + oydWt, where a, y0, and o are positive constants and dWt is a Wiener process. (a) What is the process followed by the bond price? (b) What is the expected instantaneous return (including interest and capital gains) to the holder of the bond?arrow_forwardThe real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT? Select one: a. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond. b. The conditions in the problem cannot all be true--they are internally inconsistent. c. The yield on a 2-year T-bond must exceed that on a 5-year T-bond. d. The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond. e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Bonds Explained for Beginners | Bond Types 101; Author: TommyBryson;https://www.youtube.com/watch?v=yuKmHTgqZ5o;License: Standard Youtube License