please solve these question # 6.10. ading (eBook) f Financial Management, Concie

Question

please solve these question # 6.10.

ading (eBook) f Financial Management, Concie ? 6-10 INFLATION Due to a inflation rate in Year 2 and thereafter is expected to be constant at some level a Assume that the expectations recession, expected inflation this year is only 3 .25%. However, the bove 3.2590. theory holds and the real risk-free rate (r) is 2.5%. Ifthe ield on 3-year Treasury bonds equals the 1-year yield plus 1.5%, what inflation rate is expected after Year 1? Answer 6-11 DEFAULT RISK PREMIUM A company's 5-year bonds are yielding 7% per year. Treasury bonds with the same maturity are yielding 5.2% per year, and the real risk-free rate (r) is 2.75%. The average inflation premium is 20s%; and the maturity risk premium is estimated O Trpe hese to seasch

Explanation / Answer

Basic relevant equations:

rt = r* + IPt + DRPt + MRPt + IPt.

But here IPt is the only premium,

so rt = r* + IPt.

IPt = Avg. inflation = (I1 + I2 + . . .)/N.

We know that I1 = IP1 = 3.25% and r* = 2.5%.

Therefore,rT1 = 3.25% + 2.5% = 5.75%.

rT3 = rT1 + 1.5% = 5.75% + 1.5% = 7.25%.

But,rT3 = r* + IP3 = 2.5% + IP3 = 7.25%,

so IP3 = 7.25% – 2.5% = 4.75%.

We also know that It = Constant after t = 1.

We can set up this table:

r* I Avg. I = IPt r = r* + IPt

IP3= 4.75% = (3.25% + 2IP)/3

14.25% = 3.25% + 2IP

2IP = 11%

IP = 5.5%

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.