EBK CFIN
6th Edition
ISBN: 9781337671743
Author: BESLEY
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 5, Problem 20PROB
Summary Introduction
Yield:
Yield is the return to be earned from an investment, if hold it for a specific period.
Yield includes payment of interest or dividend but does not include capital appreciation.
Calculate the yield as follows:
Given one year Treasury bond rate is 2.4%, one year bond yield is equal to 4.8%, Liquidity premium is equal to 0.3 and maturity risk premium is 0.15.
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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.
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
The Expectations theory suggests that under certain conditions all bonds outstanding, especially Treasury bonds, must have identical total returns over a 1-year holding period, independently of their final maturity.
suppose that today’s interest rate on a 2-year default free zero-coupon Treasury bond that pays $100 at maturity (0i0,2) is 6%. What is today’s price of such a bond (that is, what would you pay to purchase such a bond)?
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