Foundations of Financial Management
16th Edition
ISBN: 9781259277160
Author: Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 6, Problem 16P
Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. Do an analysis similar to that in Table 6-6.
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Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data.
Note: Input your answers as a percent rounded to 2 decimal places.
Interest Rate
1-year T-bill at beginning of year 1
6%
1-year T-bill at beginning of year 2
9%
1-year T-bill at beginning of year 3
10%
1-year T-bill at beginning of year 4
12%
Expected Return
2 year security
%
3 year security
%
4 year security
%
Suppose that the current one-year rate and expected one-year T-bill rates over the following three years (i.e., year 2, 3, and 4, respectively) are as follows: 1R1 = 5%, E(2r1)=6%, E(3r1)= 7%, E(4r1)=7.5%
Using the unbiased expectations theory, calculate the current rates for three-year and four-year Treasury securities.
An analyst evaluating securities has obtained the following information. The real rate of interest is 2.4% and is expected to remain constant for the next 5 years. Inflation is expected to be 2.3% next year, 3.3% the following year, 4.3% the third year, and 5.3% every year thereafter. The maturity risk premium is estimated to be 0.1 × (t – 1)%, where t = number of years to maturity. The liquidity premium on relevant 5-year securities is 0.5% and the default risk premium on relevant 5-year securities is 1%.
a. What is the yield on a 1-year T-bill? Round your answer to one decimal place.
b. What is the yield on a 5-year T-bond? Round your answer to one decimal place.
c. What is the yield on a 5-year corporate bond? Round your answer to one decimal place.
Chapter 6 Solutions
Foundations of Financial Management
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