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 four 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 Gauge Imports Inc.'s bonds is 0.55%. 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% 1.05% A. ВB 1.45% Gauge Imports Inc. 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. 5.25% 8.58% 8.03% 7.48% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? A AAA-rated bond has less default risk than a BB-rated bond. The yield on a AAA-rated bond will be higher than the yield on a BB-rated bond
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 four 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 Gauge Imports Inc.'s bonds is 0.55%. 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% 1.05% A. ВB 1.45% Gauge Imports Inc. 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. 5.25% 8.58% 8.03% 7.48% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? A AAA-rated bond has less default risk than a BB-rated bond. The yield on a 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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Transcribed Image Text: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 four 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 Gauge Imports Inc.'s bonds is 0.55%. 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%
1.05%
A.
ВB
1.45%
Gauge Imports Inc. 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.
5.25%
8.58%
8.03%
7.48%
Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the
following will be true?
A AAA-rated bond has less default risk than a BB-rated bond.
The yield on a AAA-rated bond will be higher than the yield on a BB-rated bond
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