EBK CFIN
6th Edition
ISBN: 9781337671743
Author: BESLEY
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 5, Problem 7PROB
Summary Introduction
Expected real interest rate is the interest rate of an investors receives or expects to receive after allowing inflation.
Yield on two-year treasury bond is 5% and one year is 4%. The maturity risk premium is zero.
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Suppose the yield on a two-year-old Treasury bond is 5 percent and the yield on a one-year Treasury bond is a 4 percent. If the maturity risk premium (MRP) on these bonds is zero (0), what is the expected one-year interest rate during the second year (Year 2)?
Suppose that the yield curve shows that the one-year bond yield is 8 percent, the two-year yield is 7 percent, and the three-year yield
is 7 percent. Assume that the risk premium on the one-year bond is zero, the risk premium on the two-year bond is 1 percent, and the
risk premium on the three-year bond is 2 percent.
a. What are the expected one-year interest rates next year and the following year?
The expected one-year interest rate next year =
The expected one-year interest rate the following year
b. If the risk premiums were all zero, as in the expectations hypothesis, what would the slope of the yield curve be?
The slope of the yield curve would be (Click to select)
%
%
Suppose that the interest rate on one-year bonds is currently 4 percent and is expected to be 5 percent in one year and 6 percent in two years. Using the expectations hypothesis, compute the yields on two- and three-year bonds and plot the yield curve.
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- What do you have to do to the interest rate and years of maturity if a bond pricing problem tells you that interest is compounded quarterly?arrow_forwardSuppose the real risk-free rate of interest is 2%. Inflation is expected to be 2% for 2 years and then 3% thereafter. The maturity risk premium is 0.2% (t). where t is the number of years until maturity. The default risk premium is 2%. The liquidity premium is 1%. What is the nominal interest rate on a 4 year bond? 9.1% 7.8% 7.1%arrow_forwardSuppose you can observe that 1-year bond interest rate is 4%, 2-year bond interest rate is 8%, and 3-year bond interest rate is 10% at time t. It is also known that the term premium on a 2-year bond is 1% and the term premium on a 3-year bond is 1.5%. a) What are the market's expected 1-year bond interest rates for the next two years from time t? b) How to interpret those expected short-term interest rates? (what would be the "possible" economic meanings in the expected short- term interest rates?) Discuss as least two "candidates" to explain them.arrow_forward
- Suppose the current interest rate on a one-year bond is 2% and the current interest rate on a two-year bond is 4%. The term premium on a two-year bond is 1%. According to the expectations hypothesis, what interest rate should we expect on a one-year bond next year? Answer as a percentage to one decimal place and do not include symbols (e.g. $, %, commas) in your answer. Answer:arrow_forwardAssume 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_forwardSuppose 1-year Treasury bonds yield 3.10% while 2-year T-bonds yield 4.80%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now?arrow_forward
- Assume that the real risk free rate is 2% and the average expected inflation rate is 3% for each future year. The default risk premium and the liquidity premium for bond x are each 1% and the applicable Maturity Risk premium is 2% what is bond x’s interest rate. Round to 2 decimal placesarrow_forwardIf 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?arrow_forwardSuppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.40%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now?arrow_forward
- Consider a 10-year bond with a face value of $1,000 that has a coupon rate of 5.8%, with semiannual payments.arrow_forwardThe current zero-coupon yield curve for risk-free bonds is as follows: What is the risk-free interest rate for a five-year maturity? The risk-free interest rate for a five-year maturity is _____%. (Round to two decimal places.)arrow_forwardAssume the real risk-free rate of interest is 2%, inflation will be 3% for the next 2 years then inflation will be 4% thereafter, the maturity risk premium is 0.1%(t-1), the default risk premium is 2% and the liquidity premium is 1%. What is the yield on a 5-year bond?arrow_forward
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