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1. The real risk-free rate of interest is 1%. Inflation is expected to be 4% the next 2 years and 7% during the next 3 years after that. Assume that the maturity risk premium is zero. What is the yield on 3-year Treasury securities? (5 points)

2. The real risk-free rate of interest is 2.5%. Inflation is expected to be 2% the next 2 years and 4% during the next 3 years after that. Assume that the maturity risk premium is zero. What is the yield on 5-year Treasury securities? (5 points)

3. A Treasury bond that matures in 20 years has a yield of 6%. A 20-year corporate bond has a yield of 10%. Assume that the liquidity premium on the corporate bond is 1%. What is the default risk premium on the corporate bond? (5 points)

4. You have determined the following data for a given bond:

Real risk-free rate = 2%

Inflation premium = 8%

Default risk premium = 3%

Liquidity premium = 2%

Maturity risk premium = 1%

What is the interest rate on long-term (long maturity) Treasury securities, or T-bonds, of the relevant maturity? (5 points)

5.Assume that the real risk-free rate is 4% and that inflation is expected to be:

Year 1: 7%

Year 2: 4%

Year 3: 3%

Year 4: 3%
Year 5: 3%

Assume that all Treasury bonds are highly liquid and free of default risk.

If 2-year and 5-year Treasury bonds both yield 11%, what is the difference in the maturity risk premiums on the two bonds: What is MRP5 –MRP2? (5 points)

1. ABC Corp. has a bond issue outstanding with an annual coupon of 6%, made in annual payments, and 5 years remaining until maturity. The par value of the bond is $1000. Determine the current value of the bond if present market conditions justify a 12% yield. (10 points)

2. ABC Corp. has a bond issue outstanding with an annual coupon of 6%, made in semi-annual payments, and 7 years remaining until maturity. The par value of the bond is $1000. Determine the current value of the bond if present market conditions justify a 10% yield. (10 points)

Answer 1