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A 2-year Treasury security currently earns 2
- A 2-year Treasury security currently earns 2.12 percent. Over the next two years, the real risk-free rate is expected to be 1.45 percent per year and the inflation premium is expected to be 0.45 percent per year. What is the maturity risk premium on the 2-year Treasury security.
- One-year Treasury bills currently earn 2.05 percent. You expect that one year from now, 1-year Treasury bill rates will increase to 2.25 percent. If the unbiased expectations theory is correct, what should the current rate be on 2-year Treasury securities?
- NikkiG's Corporation's 10-year bonds are currently yielding a return of 6.20 percent. The expected inflation premium is 1.15 percent annually and the real risk-free rate is expected to be 2.40 percent annually over the next ten years. The liquidity risk premium on NikkiG's bonds is 0.40 percent. The maturity risk premium is 0.25 percent on 3-year securities and increases by 0.06 percent for each additional year to maturity. What is the default risk premium on NikkiG's 10-year bonds.
- The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 2.30 percent and on 10-year Treasury bonds is 4.25 percent. Assume that the maturity risk premium is zero. What is the expected rate on a 5-year Treasury bond purchased five years from today, E(5r5).
Expert Solution
Solution 1)
2 year treasury security - 2.12%
Over next 2years
real risk expected rate = 1.45%
Expected inflation premium=0.45%
To calculate maturity risk premium on 2 year treasury
Return on 2 year treasury security = Real risk free rate + inflation premium +Maturity risk premium
= 2.12%=1.45% +0.45% +maturity risk premium
2.12%=1.9%+ Maturity risk premium
Maturity risk Premium = 0.22%
Solution 2) current rate =√2.05*2.25 = 2.147
Solution 3)
Bond Yield = 6.20%
Inflation Premium = 1.15%
Real Risk-free Rate = 2.40%
Liquidity Risk Premium = 0.40%
Maturity Risk Premium = 0.25% + 0.06% * 7
Maturity Risk Premium = 0.67%
Bond Yield = Real Risk-free Rate + Inflation Premium + Liquidity Risk Premium + Maturity Risk Premium + Default Risk Premium
6.20% = 2.40% + 1.15% + 0.40% + 0.67% + Default Risk Premium
6.20% = 4.62% + Default Risk Premium
Default Risk Premium = 1.58%
So, default risk premium on NikkiG's 10-year bonds is 1.58%
Solution 4)
Expected Return = 1 + 1R 10 = {(1 + 1R 5 )^5 (1 + E( 5r5 ))^ 5 } ^1/10
= 1+ 4.25% = {(1 + 2.30%)^ 5 (1 + E( 5r5 ))^ 5 } ^1/10
E( 5r5 ) = {(1.0425)^10 / (1 + 0.0230)^ 5 }^ 1/5 - 1 = 6.24%
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