Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
expand_more
expand_more
format_list_bulleted
Concept explainers
Question
Chapter 3, Problem 18P
Summary Introduction
To determine: The current risk-free interest rate under no arbitrage opportunities.
Introduction:
Arbitrage pricing theory is an asset-pricing model. No arbitrage is an arbitrage-free condition. Under this situation, all the assets are priced appropriately and there are no chances of one’s gain to overcome the market gains without facing any risks.
Expert Solution & Answer
Trending nowThis is a popular solution!
Students have asked these similar questions
Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 4.00%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-product term, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.)
Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%, and a
maturity risk premium of 0.10% per year to maturity applies, i.e., MRP 0.10% (t), where t is the
years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you
expect on a 4-year Treasury security?
O 7.80%
O 7.90%
O 7.70%
O 8.10%
O 8.00%
A.Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 6.60%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
a.
9.70%
b.
9.12%
c.
8.83%
d.
8.54%
e.
7.47%
B.
Beranek Corp has $625,000 of assets (which equal total invested capital), and it uses no debt—it is financed only with common equity. The new CFO wants to employ enough debt to raise the total debt to total capital ratio to 40%, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?
a.
$262,500
b.
$202,500
c.
$250,000
d.
$195,000
e.
$212,500
Chapter 3 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Ch. 3.1 - Prob. 1CCCh. 3.1 - If crude oil trades in a competitive market, would...Ch. 3.2 - How do you compare costs at different points in...Ch. 3.2 - Prob. 2CCCh. 3.3 - What is the NPV decision rule?Ch. 3.3 - Why doesnt the NPV decision rule depend on the...Ch. 3.4 - Prob. 1CCCh. 3.4 - Prob. 2CCCh. 3.5 - If a firm makes an investment that has a positive...Ch. 3.5 - Prob. 2CC
Ch. 3.5 - Prob. 3CCCh. 3.A - The table here shows the no-arbitrage prices of...Ch. 3.A - Suppose security Chas a payoff of 600 when the...Ch. 3.A - Prob. A.3PCh. 3.A - Prob. A.4PCh. 3.A - Prob. A.5PCh. 3.A - Consider a portfolio of two securities: one share...Ch. 3.A2 - Why does the expected return of a risky security...Ch. 3.A2 - Prob. 2CCCh. 3.A3 - Prob. 1CCCh. 3.A3 - Prob. 2CCCh. 3 - Honda Motor Company is considering offering a 2000...Ch. 3 - You are an international shrimp trader. A food...Ch. 3 - Prob. 3PCh. 3 - Prob. 4PCh. 3 - You have decided to take your daughter skiing in...Ch. 3 - Suppose the risk-free interest rate is 4%. a....Ch. 3 - You have an investment opportunity in Japan. It...Ch. 3 - Your firm has a risk-free investment opportunity...Ch. 3 - You run a construction firm. You have just won a...Ch. 3 - Your firm has identified three potential...Ch. 3 - Your computer manufacturing firm must purchase...Ch. 3 - Prob. 12PCh. 3 - Prob. 13PCh. 3 - An American Depositary Receipt (ADR) is security...Ch. 3 - Prob. 15PCh. 3 - An Exchange-Traded Fund (ETF) is a security that...Ch. 3 - Consider two securities that pay risk-free cash...Ch. 3 - Prob. 18P
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
- D3) The value of a derivative that pays off $100 after one year if a company has defaulted during the year is $5. The value of a derivative that pays off $100 after one year if a company has not defaulted is $97. (a) What is the risk-free rate? (b) What is the risk-neutral probability of default?arrow_forwardGive typing answer with explanation and conclusionarrow_forwardAssume investors are indifferent among security maturities. Today, the annualized 2-year interest rate is 2.20 percent, and the 1-year interest rate is 2 percent. What is the forward rate according to the pure expectations theory? Group of answer choices 2.25% 2.20% 2.00% 2.40%arrow_forward
- Suppose the real risk-free rate is 3.2%, the average future inflation rate is 1.9%, and a maturity premium of 0.05% per year to maturity applies, i.e., MRP = 0.05% (t), where t is the years to maturity. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is NOT valid? O 6.25% O 6.55% O 5.65% O 5.95% O 5.35%arrow_forwardsuppose that real risk free rate is 3.40% and the future rate of inflation is expected to be constant at 1.50%. What rate of return would you expect on a Treasury Bill, assuming the pure expectations theory is valid.arrow_forwardSuppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, and a maturity premium of 0.10% per year to maturity applies, i.e., MRP = 0.10. What rate of return would you expect on a 1-year (short term) Treasury security?arrow_forward
- A riskfree security pays a dividend of $200 after one year, $400 after two years, $800 after three years, and thereafter it never pays dividends again. The riskfree interest rate is 3%. What is the current price of the security?arrow_forwardThe pure expectations theory, or the expectations hypothesis, asserts that long-term interest rates can be used to estimate future short-term interest rates. Based on the pure expectations theory, is the following statement true or false? A certificate of deposit (CD) for two years will have the same yield as a CD for one year followed by an investment in another one-year CD after one year True False The yield on a one-year Treasury security is 5.6100%, and the two-year Treasury security has a 8.4200% yield. Assuming that the pure expectations theory is correct, what is the market's estimate of the one-year Treasury rate one year from now? 14.3637% 9.6135% 11.3100% 12.8934% Recall that on a one-year Treasury security the yield is 5.6100% and 8.4200% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0.2000%. What is the market's estimate of the one-year Treasury rate one year from now? 12.4260%…arrow_forwardThe pure expectations theory, or the expectations hypothesis, asserts that long-term interest rates can be used to estimate future short-term interest rates. Q. Suppose the yield on a two-year Treasury security is 5.83%, and the yield on a five-year Treasury security is 6.20%. Assuming that the pure expectations theory is correct, what is the market’s estimate of the three-year Treasury rate two years from now? (Note: Do not round your intermediate calculations.) a. 6.45% b. 6.69% c. 5.46% d. 6.61%arrow_forward
- Consider two securities that pay risk-free cash flows over the next two years and that have the current market prices shown here: Security Price Today Cash Flow in One Year Cash Flow in Two Years B1 $192 $200 0 B2 $176 0 $200 What is the no-arbitrage price of a security that pays cash flows of $200 in one year and $200 in two years? What is the no-arbitrage price of a security that pays cash flows of $200 in one year and $1600 in two years? Suppose a security with cash flows of $100 in one year and $200 in two years is trading for a price of $260. What arbitrage opportunity is available?arrow_forwardUnder the liquidity preference theory, if inflation is expected to be falling over the next few years, long-term interest rates will be higher than short-term rates. True/false/uncertain? Why?arrow_forwardThe pure expectations theory, or the expectations hypothesis, asserts that long-term interest rates can be used to estimate future short-term interest rates. Based on the pure expectations theory, is the following statement true or false? Q1. A certificate of deposit (CD) for two years will have the same yield as a CD for one year followed by an investment in another one-year CD after one year. a. True b. False Q2. The yield on a one-year Treasury security is 4.9200%, and the two-year Treasury security has a 5.9040% yield. Assuming that the pure expectations theory is correct, what is the market’s estimate of the one-year Treasury rate one year from now? (Note: Do not round your intermediate calculations.) a. 5.8627% b. 6.8973% c. 7.8629% d. 8.7596% Q3. Recall that on a one-year Treasury security the yield is 4.9200% and 5.9040% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0.2%. What is…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