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Fundamentals of Financial Manageme...

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

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

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

EXPECTED INTEREST RATE The real risk-free rale is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?

Summary Introduction

To identify: The yield on the 2 year and 3 year treasury securities.

Yield: Yield is that percentage of the securities at which the return is provided by the company to its investors. Yield can be there in the form of dividend and interest.

Explanation

Solution:

In order to calculate the yield on 2 year and 3 year securities, the inflation rate for the 2 year and 3 year need to calculate.

Compute the inflation rate:

2 Year

Given,

Inflation rate for the first year is 2%.

Inflation during next 2 years is 4%.

Formula to calculate the inflation rate,

ExpectedInflationRate=InflationatFirstYear+InflationattheSecondYear2

Substitute 2% for inflation at first year and 4% for inflation at second year.

ExpectedInflationRate=2%+4%2=6%2=3%

The expected inflation rate for 2 year bond is 3%.

3 year

Given,

Inflation rate for the first year is 2%.

Inflation during next 2 years is 4%.

Formula to calculate the inflation rate,

ExpectedInflationRate=(InflationatFirstYear+InflationattheSecondYear+InflationattheThirdYear)3

Substitute 2% for inflation at first year and 4% for inflation at second year and 4% for inflation at third year

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