You are given the following data: Real Risk-Free Rate 4% Constant inflation premium 7% Maturity risk premium 1% Default risk premium for AAA bonds 3% Liquidity premium for long term T bonds 2% Assume that a highly liquid market does not exist for long term bonds, and the expected rate of inflation is constant. Given these conditions: a. nominal risk-free rate for T bills is? b. the rate of the long term treasury bonds is?

You are given the following data: Real Risk-Free Rate 4% Constant inflation premium 7% Maturity risk premium 1% Default risk premium for AAA bonds 3% Liquidity premium for long term T bonds 2% Assume that a highly liquid market does not exist for long term bonds, and the expected rate of inflation is constant. Given these conditions: a. nominal risk-free rate for T bills is? b. the rate of the long term treasury bonds is?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter4: Bond Valuation

Section: Chapter Questions

Problem 9MC

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You are given the following data: r* = real risk-free rate = 4% Constant inflation premium = 7% Maturity risk premium = 1% Default risk premium for AAA bonds = 3% Liquidity premium for long-term T-bonds = 2% Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the nominal risk-free rate for T-bills is ____, and the rate on long-term Treasury bonds is ____.a. 4%; 14%b. 4%; 15%c. 11%; 14%d. 11%; 15%e. 11%; 17%
Which of the following statements is/are most CORRECT? O 11 A yield curve depicts the relationship between bond's 'time to maturity and its yield to maturity. 2) A premium bond's price will decline over time if the required return remains unchanged. 3) A discount bond's price will decline over time if the required return remains unchanged. 4) Both a and b are correct.
You are given the following data: • k* = real risk-free rate = 4%. • Constant inflation premium = 7%. • Maturity risk premium = 1%. • Default risk premium for AAA bonds = 3%. • Liquidity premium for long-term T-bonds = 2%. Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the nominal risk-free rate for T-bills is , and the rate on long-term Treasury bonds is 4%; 14% 4%; 15% 11%; 14% 11%; 15%
According to the expectations theory of the term structure, O a when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future. O b. when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future. O c. buyers of bonds prefer short-term to long-term bonds. O d. all of the above. O e. only A and B of the above.
Calculating the risk premium on bonds The text presents a formula where (1+1) = (1-p)(1 +i+x) + p(0) where i is the nominal interest rate on a riskless bond x is the risk premium p is the probability of default (bankruptcy) If the probability of bankruptcy is zero, the rate of interest on the risky bond is When the nominal interest rate for a risky borrower is 8% and the nominal policy rate of interest is 3%, the probability of bankruptcy is %. (Round your response to two decimal places.) When the probability of bankruptcy is 6% and the nominal policy rate of interest is 4%, the nominal interest rate for a risky borrower is %. (Round your response to two decimal places.) When the probability of bankruptcy is 11% and the nominal policy rate of interest is 4%, the nominal interest rate for a risky borrower is %. (Round your response to two decimal places.) The formula assumes that payment upon default is zero. In fact, it is often positive. How would you change the formula in this case?…
Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Characteristic Symbol Component This is the rate for a short-term riskless security when inflation Maturity risk premium Inflation premium Liquidity risk premium is expected to be zero. It is calculated by adding the inflation premium to r* This is the difference between the interest rate on a U.S. Real risk-free rate Treasury bond and a corporate bond of the same profile-that Nominal risk-free rate is, the same maturity and marketability. Default risk premium This is the premium added to the risk-free rate that reflects the average sustained increase in the general level of prices for goods and services expected over the security's entire life. This is the premium that reflects the risk associated with changes in interest rates for a long-term security. This is the premium added to the equilibrium interest…
Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Characteristic Component Symbol This is the premium added to the real risk-free rate to compensate for a decrease in purchasing power over time. It is based on the bond’s rating; the higher the rating, the lower the premium added, thus lowering the interest rate. It is calculated by adding the inflation premium to r*. It changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people’s time preferences for consumption. As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for this uncertainty. This premium is added when a security lacks marketability,…
Which one of the following statements is NOT true? As interest rates increase, bond prices increase. Interest rate risk is the risk that bond prices will change as interest rates change. Interest rate changes and bond prices are inversely related. Long-term bonds have more price volatility than short-term bonds of similar risk
The interest rate on debt, r, is equal to the real risk-free rate plus an inflation premium plus a default risk premium plus a liquidity premium plus a maturity risk premium. The interest rate on debt, r, is also equal to the -Select-purerealnominalCorrect 1 of Item 1 risk-free rate plus a default risk premium plus a liquidity premium plus a maturity risk premium.The real risk-free rate of interest may be thought of as the interest rate on -Select-long-termshort-termintermediate-termCorrect 2 of Item 1 U.S. Treasury securities in an inflation-free world. A Treasury Inflation Protected Security (TIPS) is free of most risks, and its value increases with inflation. Short-term TIPS are free of default, maturity, and liquidity risks and of risk due to changes in the general level of interest rates. However, they are not free of changes in the real rate. Our definition of the risk-free rate assumes that, despite the recent downgrade, Treasury securities have no meaningful default risk.The…
Which type of bonds offer a higher yield? Callable bonds Noncallable bonds Answer the following question based on your understanding of interest rate risk and reinvestment risk. True or False: Assuming all else is equal, the shorter a bond's maturity, the more its price will change in response to a given change in interest rates. False True
The rate of return on a bond held to its maturity date is called the bond’syield to maturity. If interest rates in the economy rise after a bond hasbeen issued, what will happen to the bond’s price and to its YTM? Doesthe length of time to maturity affect the extent to which a given change ininterest rates will affect the bond’s price? Why or why not?
Suppose 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?