A company\'s 5-year bonds arc yielding 8.8% per year. Treasury bonds with the sa

Question

A company's 5-year bonds arc yielding 8.8% per year. Treasury bonds with the same maturity arc yielding 6.3% per year, and the real risk-free rate (r) is 2.45%. The average inflation premium is 3.45%. and the maturity risk premium is estimated to be 0.1 (t - 1 f%. where t = number of years to maturity. If the liquidity premium is 1.05%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places. Expectations Theory and Inflation Suppose 2-year Treasury bonds yield 5.1%, while I-year bonds yield 3.2%. r is 1.75%. and the maturity risk premium is zero. a. Using the expectations theory, what is the yield on a 1-year bond, one year from now? Calculate the yield using a geometric average. Round your answer to two decimal places. b. What is the expected inflation rate in Year 1? Round your answer to two decimal places. c. What is the expected inflation rate in Year 2? Round your answer to two decimal places. A 5-year Treasury bond h3s a 4.8% yield. A 10-year Treasury bond yields 6.65%, and a 10-year corporate bond yields 9.9%. The market expects that inflation will average 3.75% over the next 10 years (IP, - 3.75%). Assume that there is no maturity risk premium (MRP = 0), and that the annual real risk-free rate, r*. will remain constant over the next 10 years.

Explanation / Answer

Answer: 6-11

r = r* + IP +DRP+ LP + MRP

r = 8.8%

r* = 2.45%

IP = 3.45%

LP = 1.05%

MRP = 0.1 x (t-1)% = 0.1 x (5-1)% = 0.4%

DRP of 5-year Corporate Bond:

DRP = r – r* - IP – LP – MRP

= 8.8% - 2.45% -3.45% - 1.05% - 0.4%

= 1.45%

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