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1.
A fixed-income analyst has made the following assessments:
(1) The real risk-free rate is expected to remain at 2.5 percent for the
next ten years.
(2) Inflation is expected to be 3 percent this year, 4 percent next year,
and 5 percent a year thereafter.
(3) The maturity risk premium is 0.1%(t - 1), where t = the maturity of the
bond (in years).
A five-year corporate bond currently yields 8.5 percent. What will be the
yield on the bond, one year from now, if the above assessments are correct,
and the bond’s default premium and liquidity premium remain unchanged?
(Points: 10)
2.
You read in
The Wall Street Journal
that 30-day T-bills are currently yielding
8 percent. Your brother-in-law, a broker at Kyoto Securities, has given you
the following estimates of current interest rate premiums:
Inflation premium 5%
Liquidity premium 1%
Maturity risk premium 2%
Default risk premium 2%
Based on these data, the real risk-free rate of return is
(Points: 10)
3.
A financial planner has offered you three possible options for receiving cash
flows. You must choose the option that has the highest present value.

(1) $1,000 now and another $1,000 at the beginning of each of the 11
subsequent months during the remainder of the year, to be deposited in an
account paying a 12 percent nominal annual rate, but compounded monthly (to be
left on deposit for the year).
(2) $12,750 at the end of the year (assume a 12 percent nominal interest

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