The risk free rate of interest is 2.5%. Inflation is expected to be 1.6% this ye

Question

The risk free rate of interest is 2.5%. Inflation is expected to be 1.6% this year, 2% next year and 3% the following years. Assume the maturity risk premium is calculated to be. 15 Times (t-1)%, default risk premium is fixed at 1% and liquidity premium is fixed at 1%. What is the yield on a 5 year bond? A 9 year bond? Currently, the price of energy products as fallen in the past year by 40%. According to our class discussions, could this security described above be a current Russian (Russia is heavily dependent on Oil) bond? Explain why or why not. Think in terms of how healthy the economy is and risk.

Explanation / Answer

Answer:a) r = r* + IP + MRP + DRP + LP

=2.5%+[(1.6%+2%+3%+3%+3%)/5]+0.6%+1%+1%

=7.62%

MRP=0.15(5-1)%=0.6%

Answer:b) r = r* + IP + MRP + DRP + LP

=2.5%+[(1.6%+2%+3%+3%+3%+3%+3%+3%+3%)/9]+1.2%%+1%+1%

=8.43%

MRP=0.15(9-1)%=1.2%

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