Financial Market Review

# Financial Market Review - 4-1k = 3 I1= 2 I2= 4 I3= 4 MRP =...

This preview shows pages 1–3. Sign up to view the full content.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: 4-1k* = 3%; I1= 2%; I2= 4%; I3= 4%; MRP = 0; kT2= ?; kT3= ?k = k* + IP + DRP + LP + MRP.Since these are Treasury securities, DRP = LP = 0.kT2= k* + IP2.IP2= (2% + 4%)/2 = 3%.kT2= 3% + 3% = 6%.kT3= k* + IP3.IP3= (2% + 4% + 4%)/3 = 3.33%.kT3= 3% + 3.33% = 6.33%.4-2kT10= 6%; kC10= 8%; LP = 0.5%; DRP = ?k = k* + IP + DRP + LP + MRP.kT10= 6% = k* + IP + MRP; DRP = LP = 0.kC10= 8% = k* + IP + DRP + 0.5% + MRP.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.kC10= 8% = k* + IP + MRP + 0.5% + DRP. But we know from above that k* + IP + MRP = 6%; therefore,kC10= 8% = 6% + 0.5% + DRP1.5% = DRP.4-3kT1= 5%; 1kT1= 6%; kT2= ?kT2= = 5.5%.4-4k* = 3%; IP = 3%; kT2= 6.2%; MRP2= ?kT2= k* + IP + MRP = 6.2%kT2= 3% + 3% + MRP = 6.2%MRP = 0.2%.4 - 1SOLUTIONS TO END-OF-CHAPTER PROBLEMS4-5Let x equal the yield on 2-year securities 4 years from now:7.5% = [(4)(7%) + 2x]/60.45 = 0.28 + 2xx = 0.085 or 8.5%.4-6k = k* + IP + MRP + DRP + LP.k* = 0.03.IP = [0.03 + 0.04 + (5)(0.035)]/7 = 0.035.MRP = 0.0005(6) = 0.003.DRP = 0.LP = 0.kT7= 0.03 + 0.035 + 0.003 = 0.068 = 6.8%.4-7a. k1= 3%, andk2= = 4.5%,Solving for k1in Year 2, 1k1, we obtain1k1= (4.5% × 2) - 3% = 6%.b. For riskless bonds under the expectations theory, the interest rate for a bond of any maturity is kn= k* + average inflation over n years. If k* = 1%, we can solve for IPn:Year 1: k1= 1% + I1= 3%;I1= expected inflation = 3% - 1% = 2%.Year 2: k1= 1% + I2= 6%;I2= expected inflation = 6% - 1% = 5%.Note also that the average inflation rate is (2% + 5%)/2 = 3.5%, which, when added to k* = 1%, produces the yield on a 2-year bond, 4.5 percent. Therefore, all of our results are consistent....
View Full Document

## This note was uploaded on 10/13/2011 for the course MAFM FI516 taught by Professor Anthonycriniti during the Spring '10 term at Keller Graduate School of Management.

### Page1 / 8

Financial Market Review - 4-1k = 3 I1= 2 I2= 4 I3= 4 MRP =...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online