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Finance 2 & 6 - maturity risk premium A 7-year...

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1.  Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, a maturity premium of 0.08% per year to maturity applies, i.e., MRP = 0.08%(t), where t is the years to maturity. Suppose also that a liquidity premium of 0.5% and a default risk premium of 0.85 applies to A-rated corporate bonds. How much higher would the rate of return be on a 5-year A- rated corporate bond than on a 5-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)  1.15% B)  1.25% C)  1.35% D)  1.55% E)  1.45% Points Earned:  5.0/5.0  Correct Answer(s): C 2.  The real risk-free rate, r*, is 3%. Inflation is expected to average 2% a year for the next three years, after which time inflation is expected to average 3.5% a year. Assume that there is no
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Unformatted text preview: maturity risk premium. A 7-year corporate bond has a yield of 7.6%. Assume that the liquidity premium on the corporate bond is 0.4%. What is the default risk premium on the corporate bond? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. A) 1.34% B) 2.20% C) 1.45% D) 2.01% E) 0.70% Points Earned: 5.0/5.0 Correct Answer(s): A 3. SCENARIO 6-3 Assume that the real risk-free rate, r*, equals 3%, and it is expected to be constant over time. Expected inflation is expected to be 3% in Year 1, 4% in Year 2, and 5% in Year 3. Assume that the maturity risk premium (MRP) = 0. What is the interest rate on Treasury securities that mature in three years? A) 7.5% B) 7.0% C) 6.5% D) 8.0% E) 6.0% Points Earned: 5.0/5.0 Correct Answer(s): B...
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