![Principles of Corporate Finance](https://www.bartleby.com/isbn_cover_images/9781260465099/9781260465099_largeCoverImage.gif)
Principles of Corporate Finance
13th Edition
ISBN: 9781260465099
Author: BREALEY, Richard
Publisher: MCGRAW-HILL HIGHER EDUCATION
expand_more
expand_more
format_list_bulleted
Concept explainers
Question
Chapter 23, Problem 15PS
Summary Introduction
To determine: The value of debt and equity.
Expert Solution & Answer
![Check Mark](/static/check-mark.png)
Want to see the full answer?
Check out a sample textbook solution![Blurred answer](/static/blurred-answer.jpg)
Students have asked these similar questions
Consider a 1-year, 10% annual payment corporate bond priced at par value. If the recovery
rate is 30%, what is the expected loss given default?
Suppose the real risk-free rate of interest is r*=4%�*=4% and it is expected to remain constant over time. Inflation is expected to be 1.60% per year for the next two years and 3.90% per year for the next three years. The maturity risk premium is 0.1×(t−1)%0.1×�−1%, where t� is number of years to maturity, a liquidity premium is 0.45%, and the default risk premium for a corporate bond is 1.40%.
The average inflation during the first 4 years is2.37% .
What is the yield on a 4-year Treasury bond?
4.30%
8.90%
6.75%
7.05%
What is the yield on a 4-year BBB-rated bond?
8.90%
7.50%
7.05%
8.45%
If the yield on a 5–year Treasury bond is 7.38% and the yield on a 6–year Treasury bond is 7.83%, the expected inflation in 6 years is . (Hint: Do not round intermediate calculations.)
Assume the Liquidity Premium Theory of the Term Structure of Interest Rates holds. The WSJ quotes 0.25% annual yield on a one-year T-note and 0.5% annual yield on a two-year T-note. Suppose the annual yield on a one-year T-note is expected to stay at 0.25% over the next 2 years. What must be the liquidity premium on a two-year T-note?
Chapter 23 Solutions
Principles of Corporate Finance
Ch. 23 - Expected yield You own a 5% bond maturing in two...Ch. 23 - Bond ratings In February 2018, Aaa bonds yielded...Ch. 23 - Bond ratings It is 2030 and the yields on...Ch. 23 - Prob. 4PSCh. 23 - Default option Other things equal, would you...Ch. 23 - Prob. 6PSCh. 23 - Prob. 7PSCh. 23 - Default option Digital Organics has 10 million...Ch. 23 - Prob. 9PSCh. 23 - Prob. 10PS
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Suppose the real risk-free rate of interest is r=4% and it is expected to remain constant over time. Inflation is expected to be 1.60% per year for the next two years and 3.90% per year for the next three years. The maturity risk premium is 0.1 x (t-1) %, where t is number of years to maturity, a liquidity premium is 0.45%, and the default risk premium for a corporate bond is 1.40%, The average inflation during the first 4 years is What is the yield on a 4-year Treasury bond? O 6.75% O 8.90% O 4.30% O 7.05% What is the yield on a 4-year BBB-rated bond? O 7.50% O 7.05 % O 8.45% 8.90% If the yield on a 5-year Treasury bond is 7.38% and the yield on a 6-year Treasury bond is 7.83%, the expected inflation in 6 years is (Hint: Do not round intermediate calculations.)arrow_forwardConsider a long forward contract to purchase a coupon-bearing bond whose current price is $910. We will suppose that the forward contract matures in 9 months. We will also suppose that a coupon payment of $45 is expected after 4 months. We assume that the 4-month and 9-month risk-free interest rates (continuously compounded) are, respectively, 3% and 4% per annum. Explain how an arbitrageur can make profits from this scenario.arrow_forwardAssume that the Pure Expectations Theory of the term structure is correct. Also assume that the interest rate today on a 9-year security is 6.40%, while the interest rate today on a 15-year security is 8.00%. Finally assume that the interest rate on a 3-year security to be bought at Year 9 and held over Years 10, 11, and 12 is 6.80%. Given this information, determine the average annual return that investors today must expect that they will receive from investing in a 3-year security in 12 Years (that is, buying the security at Year 12 and holding it over Years 13, 14, and 15). O 13.00% O 12.50% 13.50% O 12.00% O 14.00%arrow_forward
- Suppose that a company defaults always happen halfway through a year and that payments on its credit default swap (CDS) are made once a year, at the end of each year. Suppose that the risk-free rate is 3% per annum with continuous compounding, the recovery rate is 30% and the default probability of the company in the CDS is 2% in any year conditional on no earlier default. What is the credit default swap spread in a three-year swap in basis points?arrow_forwardGive typing answer with explanation and conclusion to all parts The real risk-free rate, r*, is 2%, and inflation is expected to be 3.0% this year, 3.5% for the next two years; 4.0% the following year, and then 5.0% thereafter. The maturity risk premium is estimated to be 0.05%(t1), where t = number of years to maturity. Liquidity risk premium is 0.7%, default risk premium is 1%. - What are the Treasury yield for 3 years, and 6 years bonds? - What are the Corporate yield for 3 years, and 6 years bonds?arrow_forwardImagine that, during a job interview, you are handed the following quotes on U.S. Treasuries: Bond Maturity Coupon rate Yield to (years) maturity 1 1 5% 4.5% 2 2 5% 5.0% 3 3 0% 5.0% Assume that the par value is $100 and coupons are paid annually, with the first coupon payment coming in exactly one year from now. The yield to maturity is also quoted as an annual rate. What should be the 1-year forward rate between years 2 and 3? a. 6.482% ○ a. O b. 6.137% c. 6.507% O d. 6.736% NAVAarrow_forward
- 1 . Calculating interest rates 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 Harrington Horticulture Co.’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% Harrington Horticulture Co. issues 15-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. 8.33% b. 6.05% c. 7.98% d. 9.38% Based on your understanding of the determinants of interest rates, if everything else remains…arrow_forwardInterest rates on 1-year, 2-year, and 3-year Treasury bills are 5%, 6%, and 7%, respectively. Assume that the pure expectations theory holds and that the market is in equilibrium. Which of the following statements is most correct? Group of answer choices The maturity risk premium is positive. Interest rates are expected to rise over the next two years. The market expects one-year rates to be 5.5% one year from today. Answers a, b, and c are all correct. Only answers b and c are correct.arrow_forwardb. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, AA-rated corporate band. 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 = 0.03 (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 DRP. Rate 0.83% 1.03 1.35 1.73 Corporate Bond Yield Spread = DRP + LP U.S. Treasury AAA corporate 0.20% AA corporate 0.52 A corporate 0.90 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: % %arrow_forward
- Consider that the probability of a reference entity defaulting during a year conditional on no earlier defaults to be 2%; assume that defaults always happen halfway through a year; payments made on a CDS are made once a year, at the end of the year; assume the risk-free rate is 5% with continuous compounding and the recovery rate is 40%. We will value a new credit default swap. We are buying protection on an entity. CDS is 3-years. What is the required spread for a new issue? A. 103.63bps B. 98.32bps C. 132.53bps D. 124.49bpsarrow_forwardConsider that the probability of a reference entity defaulting during a year conditional on no earlier defaults to be 2%; assume that defaults always happen halfway through a year; payments made on a CDS are made once a year, at the end of the year; assume the risk-free rate is 5% with continuous compounding and the recovery rate is 40%. We will value a new credit default swap. We are buying protection on an entity. CDS is 3- years. What is the required spread for a new issue? A. 103.63bps B. 98.32bps C. 132.53bps D. 124.49bpsarrow_forwardAssume that the real risk-free rate of return, k*, is 3%, and it will remain at that level far into the future. Also assume that maturity risk premiums (MRP) increase from zero for bonds that mature in one year or less to a maximum of 1%, and MRP increases by 0.2% for each year to maturity that is greater than one year-that is, MRP equals 0.2% for two-year bond, 0.4% for a three-year bond, and so forth. Following are the expected inflation rates for the next five years: Year Inflation Rate (%) 2017 5 2018 6 2019 7 2020 8 2021 9 a) Compute the interest rate for a one-, two-, three-, four-, and five-year bond. b) If inflation is expected to equal 9% every year after 2021, what should be the interest rate for a 10- and 20-year bond? c) Plot the yield curve for the interest rates you computed in part [a] and [b]. d) Based on the curve (in part c), interpret your findings.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
![Text book image](https://www.bartleby.com/isbn_cover_images/9781337514835/9781337514835_smallCoverImage.jpg)
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT