Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
bartleby

Videos

Textbook Question
Book Icon
Chapter 3, Problem 34PS

Prices and spot interest rates What spot interest rates are implied by the following Treasury bonds? Assume for simplicity that the bonds pay annual coupons. The price of a one-year strip is 97.56%, and the price of a four-year strip is 87.48%.

Chapter 3, Problem 34PS, Prices and spot interest rates What spot interest rates are implied by the following Treasury bonds?

Expert Solution & Answer
Check Mark
Summary Introduction

To determine: The spot interest rates implied by treasury bonds.

Explanation of Solution

Determine r1:

$97.56=$100(1+r1)(1+r1)=$100$97.56=2.50%

Hence, r1 is 2.50%.

Determiner4:

$87.48=$100(1+r4)(1+r4)=$100$87.48=3.40%

Hence, r1 is 3.40%.

Determiner5:

r5 can be solved by eliminating the 1-4 cash flow of 1.5 times 2% coupon bond and 3% coupon bond.

(1.5×$928.90)$974.30=[1.5×$1,020($1,030)](1+r5)5=0.036or3.6%

Determiner3:

r3 can be solved by reducing the 3-year, 5% coupon bond and 2.5 times of reduced 5-year 2% coupon bond which eliminates the 2-year cash flow:

$928.90=$201.025+$20(1+r2)2+$20(1+r3)3+$201.0344+$1,0201.0359555.....(1)$1,054.20=$501.025+$50(1+r2)2+$1,050(1+r3)3   $1,005.419512=$50(1+r2)2+$1,050(1+r3)...........(2)

Solve equation 1 and 2

$1,005.419512(2.5×$37.030021)=$1,050(2.5×$20)(1+r3)3=$912.844459$1,000(1 +r3)3r3=0.030863, or 3.0863%

Determiner2:

r2 can be solved by 3-year bond and r3 and r1

$1,054.20=$501.025+$50(1+r2)2+$1,0501.0308633$46.932036=$50(1+r2)2=0.0322

Hence, the spot rates are 2.50%, 3.22%, 3.09%, 3.40% and 3.60 for years 1 to 5.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!
Students have asked these similar questions
If the real rate of interest is 2%, inflation is expected to be 3% during the coming year, and the default risk premium, illiquidity risk premium, and maturity risk premium for the Bonds-R-Us Corporation are all 1% each, what would be the yield (stated rate) on a Bonds-R-Us bond?
Interest premium. Estimate the default premium and the maturity premium given the following three investment opportunities: a Treasury bill with a current interest rate of 2.75%; a Treasury bond with a twenty-year maturity and a current interest rate of 4.75%; and a AAA, corporate bond with a twenty-year maturity and an interest rate of 9.5%. What is the default premium? % (Round to two decimal places.) What is the maturity premium? % (Round to two decimal places.)
Forecasting interest rates Assume the current interest rate on a one-year treasury bond(1R1) is 4.50 percent, the current rate on a two-year treasury bond (1R2) is 5.25 percent, and the current rate on a three-year treasury bond (1R3) is 6.50 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year forward rate expected on treasury bills during year 3, 3f1?

Chapter 3 Solutions

Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)

Knowledge Booster
Background pattern image
Finance
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
SEE MORE QUESTIONS
Recommended textbooks for you
Text book image
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Text book image
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:9781260013962
Author:BREALEY
Publisher:RENT MCG
Text book image
Financial Management: Theory & Practice
Finance
ISBN:9781337909730
Author:Brigham
Publisher:Cengage
Text book image
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Text book image
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Text book image
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education
What is modified duration? | Dejargoned; Author: Mint;https://www.youtube.com/watch?v=5yLIybzb_OQ;License: Standard YouTube License, CC-BY