BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section
BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

INFLATION Due to a recession, expected inflation this 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 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?

Summary Introduction

To identify: The expected inflation rate after a year.

Expectation Theory:

Expectation theory estimates the future interest without taking maturity risk into consideration. According to the expectation theory, the yield curve of investment totally depends upon the future expectation of investors.

Explanation

Solution:

In order to compute the expected inflation after a year; 1-year Treasury bond yield, 3-year treasury bonds yield, 2-year treasury bonds yield need to calculate.

Compute the 1-year Treasury bond yield

Given,

Real risk-free rate is 2%.

The one year inflation rate is 3%.

Formula to calculate the 1-year Treasury bond,

Yieldof1-yearTreasuryBond=r*+IP

Where,

  • r* is real risk-free rate.
  • IP for inflation premium.

Substitute 2% for r* and 3% for IP.

Yieldof1-yearTreasuryBond=2%+3%=5%

The yield of 1-year Treasury bond is 5%.

Compute the 3-year Treasury bond yield

The yield of 1-year Treasury bond is 5%. (Calculated)

The additional yield of 3-year Treasury bond than 1-year Treasury bond is 2%.

Formula to calculate the 3-year Treasury bond,

Yieldof3-yearTreasuryBond=Yieldof1-yearTreasuryBond+MoreYield

Substitute 5% for yield of 1-year Treasury bond and 2% for more yield.

Yieldof3-yearTreasuryBond=5%+2%=7%

The yield of 3-year Treasury bond is 7%.

Compute the 2-year treasury bonds yield

Calculated,

The yield of 1-year Treasury bond is 5% or 0.05.

The yield of 3-year Treasury bond is 7% or 0.07

Still sussing out bartleby?

Check out a sample textbook solution.

See a sample solution

The Solution to Your Study Problems

Bartleby provides explanations to thousands of textbook problems written by our experts, many with advanced degrees!

Get Started

Additional Business Solutions

Find more solutions based on key concepts

Show solutions add

CROSS RATE A currency trader observes that in the spot exchange market, 1 U.S. dollar can be exchanged for 3.63...

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

What are the arguments against increased social responsibility?

Foundations of Business (MindTap Course List)

How is a change in depreciation method accounted for? Why?

Intermediate Accounting: Reporting And Analysis

How do SSAE 16 Type 1 and Type 2 differ?

Accounting Information Systems