Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
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Chapter 5, Problem 20P
Summary Introduction
To determine: The inflation rate expected after Year 1.
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Because of a recession, the inflation rate expected for the coming year is only 3% .However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume that the real risk-free rate is r* = 2% for all maturities and that there are no maturity premiums. If 3-year Treasury notes yield 2 percentage points more than I-year notes, what inflation rate is expected after Year 1?
Because of a recession, the inflation rate expected for the coming year isonly 3%. However, the inflation rate in Year 2 and thereafter is expectedto be constant at some level above 3%. Assume that the real risk-free rateis r* 5 2% for all maturities and that there are no maturity risk premiums.If 3-year Treasury notes yield 2 percentage points more than 1-year notes,what inflation rate is expected after Year 1?
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Chapter 5 Solutions
Financial Management: Theory & Practice
Ch. 5 - Short-term interest rates are more volatile than...Ch. 5 - The rate of return on a bond held to its maturity...Ch. 5 - If you buy a callable bond and interest rates...Ch. 5 - A sinking fund can be set up in one of two ways....Ch. 5 - Prob. 1PCh. 5 - Wilson Corporations bonds have 12 years remaining...Ch. 5 - Prob. 3PCh. 5 - The real risk-free rate of interest is 4%....Ch. 5 - A Treasury bond that matures in 10 years has a...Ch. 5 - The real risk-free rate is 3%, and inflation is...
Ch. 5 - Renfro Rentals has issued bonds that have a 10%...Ch. 5 - Thatcher Corporations bonds will mature in 10...Ch. 5 - The Garraty Company has two bond issues...Ch. 5 - Prob. 10PCh. 5 - Goodwynn & Wolf Incorporated (G&W) issued a bond 7...Ch. 5 - Prob. 12PCh. 5 - You just purchased a bond that matures in 5 years....Ch. 5 - A bond that matures in 7 years sells for 1,020....Ch. 5 - Prob. 15PCh. 5 - A bond trader purchased each of the following...Ch. 5 - An investor has two bonds in his portfolio. Each...Ch. 5 - The real risk-free rate is 2%. Inflation is...Ch. 5 - Prob. 19PCh. 5 - Prob. 20PCh. 5 - Suppose Hillard Manufacturing sold an issue of...Ch. 5 - Arnot International’s bonds have a current market...Ch. 5 - Prob. 23PCh. 5 - Prob. 24SPCh. 5 - Prob. 1MCCh. 5 - Prob. 2MCCh. 5 - Prob. 3MCCh. 5 - How is the value of a bond determined? What is the...Ch. 5 - What would be the value of the bond described in...Ch. 5 - Suppose a 10-year, 10% semiannual coupon bond with...Ch. 5 - Write a general expression for the yield on any...Ch. 5 - Define the real risk-free rate (r). What security...Ch. 5 - Prob. 11MCCh. 5 - Prob. 12MCCh. 5 - Prob. 14MCCh. 5 - How are interest rate risk and reinvestment rate...Ch. 5 - What is the term structure of interest rates? What...Ch. 5 - Briefly describe bankruptcy law. If a firm were to...
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- Due to a recession, expected inflation this year is only 1.75%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 1.75%. Assume that the expectations theory holds and the real risk-free rate (r*) is 1.5%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 0.5%, what inflation rate is expected after Year 1? Round your answer to two decimal places.arrow_forwardDue to a recession, expected inflation this year is only 3.25%. However, the inflationrate in Year 2 and thereafter is expected to be constant at some level above 3.25%. Assumethat the expectations theory holds and the real risk-free rate (r*) is 2.5%. If the yield on 3-yearTreasury bonds equals the 1-year yield plus 1.5%, what inflation rate is expected after Year 1?arrow_forwardSuppose the inflation rate is expected to be 7% next year, 5% the followingyear, and 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and thatmaturity risk premiums on Treasury securities rise from zero on very short-term bonds(those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity riskpremiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer termT-bonds.a. Calculate the interest rate on 1-, 2-, 3-, 4-, 5-, 10-, and 20-year Treasury securities andplot the yield curve.b. Suppose a AAA-rated company (which is the highest bond rating a firm can have)had bonds with the same maturities as the Treasury bonds. Estimate and plot whatyou believe a AAA-rated company’s yield curve would look like on the same graphwith the Treasury bond yield curve. (Hint: Think about the default risk premium on itslong-term versus its short-term bonds.)c. On the same graph, plot the approximate yield curve of a much riskier…arrow_forward
- Suppose the inflation rate is expected to be 6.15% next year, 4% the following year, and 2% thereafter. Assume that the real risk-free rate, r*, will remain at 1.55% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds. Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places. % Calculate the…arrow_forwardSuppose the inflation rate is expected to be 6.75% next year, 4.3% the following year, and 2.3% thereafter. Assume that the real risk-free rate, r*, will remain at 1.85% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds. Calculate the interest rate on 3-year Treasury securities.arrow_forwardFor this question, the inflation rates are actual inflation levels ( so a 6-month inflation rate increase of 3% increases par by 3%, not 1.5%.) You have a semiannual treasury inflation protected security, which is 1000 par and sells at par, with a 4% coupon rate. If the inflation rates are: 2% for the first 6 months and then 0.4% for the second, 1% for the third and 0% for the fourth 6 months, find: -the individual nominal payments made for each time period Report the total amount paid including par (all coupons and par, total dollar value) (do not use $ in the answer) Note: Correct answer is 1,116.5752. Please explain and show step by step?arrow_forward
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- INFLATION Due to a recession, expected inflation this year is only 3.5%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3.5%. Assume that the expectations theory holds and the real risk-free rate (r*) is 2%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 2%, what inflation rate is expected after Year 1? Round your answer to two decimal places.arrow_forwardThe yield on two-year government bonds is 4.5%, and one-year government bonds provide a yield of 3%. In addition, the real risk-free interest rate (r*) is 1%, and the maturity risk premium is 0. 1) According to the theory of expectation, what is the rate of return on annual government bonds from now to later? Calculate the rate of return using the geometric mean. 2) What are the expected inflation rates for the first and second years respectively?arrow_forwardSuppose we have the following Treasury bill returns and inflation rates over an eight year period: Year Treasury Bills Inflation 1 10.45% 12.55% 2 11.36 16.00 3 9.06 10.29 4 8.34 7.97 5 8.88 10.29 6 11.23 12.77 7 14.11 16.98 8 15.97 16.90 a. Calculate the average return for Treasury bills and the average annual inflation rate for this period. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Treasury bills % Inflation % b. Calculate the standard deviation of Treasury bill returns and inflation over this period. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.) Treasury bills % Inflation %…arrow_forward
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