6-3: The Determinants of Market Interest Rates Problem 6-12 Maturity Risk Premiu

Question

6-3: The Determinants of Market Interest Rates

Problem 6-12
Maturity Risk Premium

An investor in Treasury securities expects inflation to be 2.35% in Year 1, 3.15% in Year 2, and 4.25% each year thereafter. Assume that the real risk-free rate is 1.75%, and that this rate will remain constant. Three-year Treasury securities yield 6.05%, while 5-year Treasury securities yield 7.20%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 - MRP3? Round your answer to two decimal places.

%

Explanation / Answer

Annual Inflation rate for 3 year treasury security =( (1+2.35%)*(1+3.15%)*(1+4.25%))^(1/3) - 1

Annual Inflation rate for 3 year treasury security = 3.25%

Annual Inflation rate for 5 year treasury security =( (1+2.35%)*(1+3.15%)*(1+4.25%)*(1+4.25%)*(1+4.25%))^(1/5) - 1

Annual Inflation rate for 5 year treasury security = 3.65%

Three-year Treasury securities yield =  real risk-free rate + Inflaton Premium + maturity risk premiums

6.05%= 1.75% + 3.25% + maturity risk premiums)

Maturity risk premiums = 1.05%

Five-year Treasury securities yield =  real risk-free rate + Inflaton Premium + maturity risk premiums

7.20% = 1.75% + 3.65% + maturity risk premiums

Maturity risk premiums = 1.80%

Differnce in MRP5 - MRP3 = 1.80 - 1.05

Differnce in MRP5 - MRP3 = 0.75%

Answer

0.75%

Related Questions

Navigate

• Browse (All)
• Browse 6
• Subjects

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