BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

Solutions

Chapter
Section
BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

MATURITY RISK PREMIUM An investor in Treasury securities expects inflation to be 2.1% in Year 1, 2.7% in Year 2, and 3.65% each year thereafter. Assume that the real risk-free rate is 1.95% and that this rate will remain constant. Three-year Treasury securities yield 5.20%, while 5-year Treasury securities yield 6.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 − MRP3?

Summary Introduction

To identify: The maturity risk premium.

Introduction:

Maturity Risk Premium:

A premium, which is paid by the borrower to its lender in the form of compensation of the interest rate uncertainty in regards of the maturity risk, is known as the maturity risk premium.

Explanation

The items required for the calculation of the maturity risk are risk free rate, Treasury bill yield and inflation premium.

Year 3

The yield is 5.20%. (Given)

The risk free rate is 1.95%. (Given)

The inflation premium on 3 year treasury security is 2.82%. (Working note)

Formula to calculate the maturity risk premium derives from the formula of corporate bond yield,

r=r*+IP+MRPMRP=r(r*+IP)

Where,

  • MRP is the maturity risk premium.
  • r is the corporate bond yield.
  • r* is the risk free rate.
  • IP is the inflation premium.

Substitute 5.20% for r, 1.95% for r* and 2.82% for IP.

MRP3=5.20%(1.95%+2.82%)=5.20%4.77%=0.43%

The maturity risk premium on year 3 treasury security is 0.43%.

Year 5

The yield is 6%. (Given)

The risk free rate is 1.95%. (Given)

The inflation premium on 5 year treasury security is 3.15%. (Working note)

Substitute 6.8% for r, 2.75% for r* and 2.82% for IP.

MRP5=6%(1.95%+3.15%)=6%5.1%=0.9%

The maturity risk premium on year 5 treasury security is 0.9%.

Compute the difference between two maturity risks

Calculated,

MRP3 is 0.43%.

MRP5 is 0.9%.

Formula to calculate the difference between two maturity risks,

Differencebetweentwomaturityrisks=MRP5MRP3

Substitute, 0.43% for MRP3 and 0.9% for MRP5

Differencebetweentwomaturityrisks=0.9%0.43%=0

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

Identify the activities associated with each phase.

Foundations of Business (MindTap Course List)

To provide a starting point for gauging a companys relative valuation, analysts often look at a companys price-...

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

Who issues a credit memorandum and why?

College Accounting (Book Only): A Career Approach

What is the bullwhip effect?

Pkg Acc Infor Systems MS VISIO CD