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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

INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 5% and inflation is expected to be 16% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk? (Hint: Refer to “The Links between Expected Inflation and Interest Rates: A Closer Look” on page 201.)

Summary Introduction

To identify: The actual yield on 4 year 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:

Item required for the calculation of actual yield are risk free rate and inflation premium.

Given,

The real risk-free rate is 5%.

The inflation premium is 16%.

Formula to calculate the actual yield on default free security,

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

Where,

  • r is actual rate.
  • r* is risk free rate.
  • IP is inflation premium

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