Liquidity premium theory: Some possible shapes • Consider the current interest rate of 5% and the following one-year interest rates expected to arise over the next four years: 6%, 7%, 8% and 9%. Assume that investors have a preference for holding short-term bonds, and as such charge the following liquidity premia for one to five year bonds: 0%, 0.25%, 0.5%, 0.75% and 1.0% Question: Calculate the interest rate on bonds with one to year maturities based on the liquidity premium theory. five

Liquidity premium theory: Some possible shapes • Consider the current interest rate of 5% and the following one-year interest rates expected to arise over the next four years: 6%, 7%, 8% and 9%. Assume that investors have a preference for holding short-term bonds, and as such charge the following liquidity premia for one to five year bonds: 0%, 0.25%, 0.5%, 0.75% and 1.0% Question: Calculate the interest rate on bonds with one to year maturities based on the liquidity premium theory. five

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter4: Bond Valuation

Section: Chapter Questions

Problem 23P

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Suppose you are considering two possible investment opportunities: a 12-yearTreasury bond and a 7-year, A-rated corporate bond. The current real risk-free rateis 4%, and inflation is expected to be 2% for the next 2 years, 3% for the following4 years, and 4% thereafter. The maturity risk premium is estimated by this formula:MRP = 0.02(t - 1)%. The liquidity premium (LP) for the corporate bond is estimatedto be 0.3%. You may determine the default risk premium (DRP), given thecompany’s bond rating, from the table below. Remember to subtract the bond’s LPfrom the corporate spread given in the table to arrive at the bond’s DRP. Whatyield would you predict for each of these two investments?RateCorporate Bond Yield
The current 1-year bond and 2-year bond interest rates are both 4% and the 1-year and 2-year term premia are 0 and 1%, respectively. The liquidity premium theory of the term structure predicts that the expected 1-year bond interest rate next year is _______%. Question 3 options:
Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Note: Input your answers as a percent rounded to 2 decimal places. 1-year T-bill at beginning of year 1 1-year T-bill at beginning of year 21 1-year T-bill at beginning of year 3 1-year T-bill at beginning of year 4 2-year security 3-year security 4-year security Expected Return % % % Interest Rate 7% 9% 10% 12%
Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Note: Input your answers as a percent rounded to 2 decimal places. Interest Rate 1-year T-bill at beginning of year 1 6% 1-year T-bill at beginning of year 2 9% 1-year T-bill at beginning of year 3 10% 1-year T-bill at beginning of year 4 12% Expected Return 2 year security % 3 year security % 4 year security %
Interest premium. Estimate the default premium and the maturity premium given the following three investment opportunities: a Treasury bill with a current interest rate of 2.75%; a Treasury bond with a twenty-year maturity and a current interest rate of 4.75%; and a AAA, corporate bond with a twenty-year maturity and an interest rate of 9.5%. What is the default premium? % (Round to two decimal places.) What is the maturity premium? % (Round to two decimal places.)
Assuming the expectations theory is the correct theoryof the term structure, calculate the interest rates in theterm structure for maturities of one to four years, andplot the resulting yield curves for the following paths ofone-year interest rates over the next four years:a. 5%; 7%; 12%; 12%b. 7%; 5%; 3%; 5%How would your yield curves change if people preferred shorter-term bonds to longer-term bonds?
You observe the following term structure: Effective Annual YTM 1-year zero-coupon bond 2-year zero-coupon bond 3-year zero-coupon bond 4-year zero-coupon bond 8.1% 8.2 8.3 8.4 a. If you believe that the term structure next year will be the same as today's, calculate the return on (i) the 1-year zero and (1i) the 4-year zero. (Do not round intermediate calculations. Round your answers to 1 decimal place.) One year return on 1-year bond One year return on 4-year bonds % % b. Which bond provides a greater expected 1-year return? O 1-year zero-coupon bond O 4-year zero-coupon bond
You observe the following term structure: Effective Annual YTM 1-year zero-coupon bond 8.1% 2-year zero-coupon bond 8.2 3-year zero-coupon bond 8.3 4-year zero-coupon bond 8.4 Required: If you believe that the term structure next year will be the same as today’s, calculate the return on (i) the 1-year zero and (ii) the 4-year zero. Which bond provides a greater expected 1-year return?
b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP Io.01(t-1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.2%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRR U.S. Treasury AAA corporate AA corporate A corporate Rate 0.83% 0.93 1.27 1.71 Corporate Bond Yield Spread - DRP + LP What yield would you predict for each of these two investments? Round your answers to three decimal places. 12-year Treasury yield: 7-year Corporate yield: 184.7 0.10% 0.44 0.88 % %
Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. (Input your answers as a percent rounded to 2 decimal places.) 1-year T-bill at beginning of year 1 1-year T-bill at beginning of year 2 1-year T-bill at beginning of year 3 1-year T-bill at beginning of year 4 2-year security 3-year security 4-year security Expected Return % % % Interest Rate 61 98 7% 108
Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. (Input your answers as a percent rounded to 2 decimal places.) Interest Rate 1-year T-bill at beginning of year 1 1-year T-bill at beginning of year 2 1-year T-bill at beginning of year 3 1-year T-bill at beginning of year 4 2% 5% 4% 7% Expected Return 0.00 % 2-year security 3-year security % 4-year 2 decimal places required.
Given a 10-year time horizon, the reinvestment rate risk is LOWEST for a: Select one: a. 4-year, 5% coupon bond b. 8-year, 8% coupon bond c. 5-year, zero-coupon bond d. 9-year, zero-coupon bond