he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 3% per year for each of the next four years and 2% 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 Dare Satellite Corp.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% 1. Dare Satellite Corp. issues 12-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. A. 6.98% B. 5.75% C. 8.08% D. 7.03% 2. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? A. An AAA-rated bond has less default risk than a BB-rated bond. B. The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond.
he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 3% per year for each of the next four years and 2% 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 Dare Satellite Corp.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury — AAA 0.60% AA 0.80% A 1.05% BBB 1.45% 1. Dare Satellite Corp. issues 12-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. A. 6.98% B. 5.75% C. 8.08% D. 7.03% 2. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? A. An AAA-rated bond has less default risk than a BB-rated bond. B. The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond.
Chapter8: Analysis Of Risk And Return
Section: Chapter Questions
Problem 10P
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Question
he real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 3% per year for each of the next four years and 2% 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 Dare Satellite Corp.’s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):
|
Rating
|
Default Risk Premium
|
|---|---|
| U.S. Treasury | — |
| AAA | 0.60% |
| AA | 0.80% |
| A | 1.05% |
| BBB | 1.45% |
1. Dare Satellite Corp. issues 12-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.
A. 6.98%
B. 5.75%
C. 8.08%
D. 7.03%
2. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?
A. An AAA-rated bond has less default risk than a BB-rated bond.
B. The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond.
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