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ARE143_CHAP_9_2012_KEY-2

ARE143_CHAP_9_2012_KEY-2 - 1 Managerial Economics(ARE 143...

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1 Managerial Economics (ARE) 143 University of California, Davis Instructor: John H. Constantine KEY —Chapter 9—Interest Rates Problem 1 : A stock had a return of 12.2 percent last year. If the inflation rate was 4.3 percent, then what was the approximate real return? This is a Fisher equation problem: 12.2% – 4.3% = 7.9% Problem 2 : Your investments increased in value by 11.4 percent last year but your purchasing power increased by only 5.8 percent. What was the inflation rate? This is a Fisher equation problem: 11.4% – 5.8% = 5.6% Problem 3 : A T-bill with 35 days to maturity is quoted at 99.43. What are (i) the bank discount yield, (ii) the bond equivalent yield, and (iii) the effective annual return (APY or EAR)? (i) 99.43 = 100 × [1 – (35/360) × DY); discount yield = .05863 (ii) bond equivalent yield = [365(.05863)]/[360 – (35)(.05863)] = .05978 (iii) EAR = [1 + .05978/(365/35)]365/35 – 1 = .06143 Problem 4 : If 10-year T-bonds have a yield of 5.2%, 10-year corporate bonds yield 7.5%, the maturity risk premium on all 10-year bonds is 1.1%, and corporate bonds have a 0.2% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
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