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On Jan 1st, 2000, the real risk-free rate is 2% and is expected to be constant...

  1. On Jan 1st, 2000, the real risk-free rate is 2% and is expected to be constant for next 20 years. Inflation is expected to be 7% next year, 5% the following year, and 3% thereafter. The maturity risk premium is estimated to be 0.2*(t -1) % and up to 1%. (t = number of years to maturity).
    1. Please estimate the term structure of US treasury.
    2. Draw the yield curve on Jan 1st, 2000 and what’s the expected yield curve on Corporate bond? (show the trend and position only)
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Answer #1
Date Real Rate Inflation Risk Premium Interest Rate Interest rate for corporate
1st Jan 2000 2% 7% 0 9% 9.00%
1st Jan 2001 2% 5% 0.2 7% 7.20%
1st Jan 2002 2% 3% 0.4 5% 5.40%
1st Jan 2003 2% 3% 0.6 5% 5.60%
1st Jan 2004 2% 3% 0.8 5% 5.80%
1st Jan 2005 2% 3% 1 5% 6.00%
1st Jan 2006 2% 3% 1 5% 6.00%
1st Jan 2007 2% 3% 1 5% 6.00%
1st Jan 2008 2% 3% 1 5% 6.00%

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