Question

Treasury securities that mature in 8 years currently have an interest rate of 8.0 percent. The...

Treasury securities that mature in 8 years currently have an interest rate of 8.0 percent. The maturity risk premium is estimated to be 0.1%(t - 1), where t is equal to the maturity of the bond (i.e., the maturity risk premium of a 1-year bond is zero). The real risk-free rate is assumed to be constant over time at 2%. For AAA rated 8-year bonds, DRP and LP combine to equal 2.5%. What is the expected rate of inflation (IP) over the next eight years?

Business   Finance   
0 0
Add a commentTranscribed image text
Next >

Homework Answers

Answer #1

Real Risk-free Rate = 2.00%

Maturity Risk Premium = 0.10% * (t - 1), t is number of years to maturity
Maturity Risk Premium = 0.10% * (8 - 1)
Maturity Risk Premium = 0.70%

Sum of Default Risk Premium and Liquidity Premium = 2.50%

Interest Rate on Treasury Security = Real Risk-free Rate + Inflation Premium + Maturity Risk Premium + Sum of Default Risk Premium and Liquidity Premium
8.00% = 2.00% + Inflation Premium + 0.70% + 2.50%
8.00% = Inflation Premium + 5.20%
Inflation Premium = 2.80%

Therefore, expected rate of inflation over the next 8 years is 2.80%

0 0
Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Log In

Sign Up

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
A 6-year Treasury bond has an interest rate of 8.5 percent. Inflation is expected to be...
A 6-year Treasury bond has an interest rate of 8.5 percent. Inflation is expected to be 5 percent each of the next three years and 6 percent each year after the third year. The maturity risk premium is estimated to be 0.1%(t-1), where t is equal to the maturity of the bond. The real risk-free rate is assumed to be constant over time. What is the real risk-free rate of interest?
Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant....
Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next four years and 6% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Gauge Imports Inc.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):...
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected...
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 5% per year for each of the next two years and 4% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Pandar Corp.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium...
Problem 6-17 Interest Rate Premiums A 5-year Treasury bond has a 4.65% yield. A 10-year Treasury...
Problem 6-17 Interest Rate Premiums A 5-year Treasury bond has a 4.65% yield. A 10-year Treasury bond yields 6.1%, and a 10-year corporate bond yields 8.8%. The market expects that inflation will average 2.85% over the next 10 years (IP10 = 2.85%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium...
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected...
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 3% per year for each of the next three years and 2% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all Rink Machine Co.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk...
A 5-year Treasury bond has a 3.5% yield. A 10-year Treasury bond yields 6.4%, and a...
A 5-year Treasury bond has a 3.5% yield. A 10-year Treasury bond yields 6.4%, and a 10-year corporate bond yields 9%. The market expects that inflation will average 3.3% over the next 10 years (IP10 = 3.3%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities:...
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected...
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 6% per year for each of the next five years and 5% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all National Transmissions Corp.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk...
A 5-year Treasury bond has a 3.25% yield. A 10-year Treasury bond yields 6.1%, and a...
A 5-year Treasury bond has a 3.25% yield. A 10-year Treasury bond yields 6.1%, and a 10-year corporate bond yields 8.5%. The market expects that inflation will average 2.1% over the next 10 years (IP10 = 2.1%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities:...
A 5-year Treasury bond has a 4.05% yield. A 10-year Treasury bond yields 6.8%, and a...
A 5-year Treasury bond has a 4.05% yield. A 10-year Treasury bond yields 6.8%, and a 10-year corporate bond yields 9.8%. The market expects that inflation will average 2.55% over the next 10 years (IP10 = 2.55%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities:...
A 5-year Treasury bond has a 4.6% yield. A 10-year Treasury bond yields 6.7%, and a...
A 5-year Treasury bond has a 4.6% yield. A 10-year Treasury bond yields 6.7%, and a 10-year corporate bond yields 9.9%. The market expects that inflation will average 2.4% over the next 10 years (IP10 = 2.4%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities:...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT