need some help with the above problem The real risk-free rate (r*) is 2.8% and i
ID: 2743139 • Letter: N
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need some help with the above problem
The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 4% per year for each of the next five years and 3% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t - 1)%, where t is the security's maturity. The liquidity premium (LP) on all Liken Holdings Inc.'s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Liken Holdings In issues six-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 8.48% 4.65% 7.98% 7.93%Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on U.S. Treasury securities always remains static. In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity.Explanation / Answer
Yield on Six Year AA rated Bond
Here Yield = Risk Free rate + Default risk Premium + Maturity Risk Premium + Liquidity Premium
= 2.8 + 0.8 + (0.1(6-1)) + 0.55
= 2.8 +0.8 + 0.5 + 0.55 = 4.65%
For Second Point
On every increasing Year of Maturity, MRP will increase by 0.1% Based on Formula Given MRP = 0.1(t-1)%
Than Second option is true.
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