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# chap6_ - r T2 = 3 3 = 6 Chapter 6 Interest Rates Integrated...

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Solutions to End-of-Chapter Problems 6-1 a.     Term     Rate       6 months 5.1%   1 year 5.5   2 years 5.6   3 years 5.7   4 years 5.8   5 years 6.0 10 years 6.1 20 years 6.5 30 years 6.3 b. The yield curve shown is an upward sloping yield curve. c. This yield curve tells us generally that either inflation is expected to increase or there is an  increasing maturity risk premium. d. It would make sense to borrow long term because each year the loan is renewed interest rates  are higher.  This exposes you to rollover risk.  If you borrow for 30 years outright you have  locked in a 6.3% interest rate each year. 6-2 T-bill rate = r* + IP       5.5% = r* + 3.25%              r* = 2.25%. 6-3 r* = 3%; I 1  = 2%; I 2  = 4%; I 3  = 4%; MRP = 0; r T2  = ?; r T3  = ? r = r* + IP + DRP + LP + MRP. Since these are Treasury securities, DRP = LP = 0. r T2 = r* + IP 2 . IP 2 = (2% + 4%)/2 = 3%.

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Unformatted text preview: r T2 = 3% + 3% = 6%. Chapter 6: Interest Rates Integrated Case 1 2 4 6 8 10 0 5 10 15 20 25 30 Interest Rate (%) Years to Maturity r T3 = r* + IP 3 . IP 3 = (2% + 4% + 4%)/3 = 3.33%. r T3 = 3% + 3.33% = 6.33%. 6-4 r T10 = 6%; r C10 = 8%; LP = 0.5%; DRP = ? r = r* + IP + DRP + LP + MRP. r T10 = 6% = r* + IP 10 + MRP 10 ; DRP = LP = 0. r C10 = 8% = r* + IP 10 + DRP + 0.5% + MRP 10 . Because both bonds are 10-year bonds the inflation premium and maturity risk premium on both bonds are equal. The only difference between them is the liquidity and default risk premiums. r C10 = 8% = r* + IP + MRP + 0.5% + DRP. But we know from above that r* + IP 10 + MRP 10 = 6%; therefore, r C10 = 8% = 6% + 0.5% + DRP 1.5% = DRP. 2 Integrated Case Chapter 6: Interest Rates...
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chap6_ - r T2 = 3 3 = 6 Chapter 6 Interest Rates Integrated...

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