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Ch6Solutions

# Ch6Solutions - Chapter 6 Problem Solutions 6-3 r = 3 I1 = 2...

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Chapter 6 Problem Solutions 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%. r T2 = 3% + 3% = 6%. r T3 = r* + IP 3 . IP 3 = (2% + 4% + 4%)/3 = 3.33%. r T3 = 3% + 3.33% = 6.33%. 6-12 First, calculate the inflation premiums for the next three and five years, respectively. They are IP 3 = (2.5% + 3.2% + 3.6%)/3 = 3.1% and IP 5 = (2.5% + 3.2% + 3.6% + 3.6% + 3.6%)/5 = 3.3%. The real risk-free rate is given as 2.75%. Since the default and liquidity premiums are zero on Treasury bonds, we can now solve for the maturity risk premium. Thus, 6.25% = 2.75% + 3.1% + MRP 3 , or MRP 3 = 0.4%. Similarly, 6.8% = 2.75% + 3.3% + MRP 5 , or MRP 5 = 0.75%. Thus, MRP 5 – MRP 3 = 0.75% – 0.40% = 0.35%. 6-18 a. Years to Real Risk-Free Maturity Rate (r*) IP** MRP r T = r* + IP + MRP 1 2% 7.00% 0.2% 9.20% 2 2 6.00 0.4 8.40 3 2 5.00 0.6 7.60 4 2 4.50 0.8 7.30 5 2 4.20 1.0 7.20 10 2 3.60 1.0 6.60 20 2 3.30 1.0 6.30 **The computation of the inflation premium is as follows: Expected Average Year Inflation Expected Inflation 1 7% 7.00% 2 5 6.00 3 3 5.00 4 3 4.50 5 3 4.20 10 3 3.60 20 3 3.30 For example, the calculation for 3 years is as follows: 3 % 3 % 5 % 7 + + = 5.00%.

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Thus, the yield curve would be as follows: b.
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Ch6Solutions - Chapter 6 Problem Solutions 6-3 r = 3 I1 = 2...

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