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Fundamentals of Financial Manageme...

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

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

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

EXPECTED INTEREST RATE The real risk-free rate is 2.05%. Inflation is expected to be 3.05% this year, 4.75% next year, and 2.3% thereafter. The maturity risk premium is estimated to be 0.05 × (t − 1)%, where t = number of years to maturity. What is the yield on a 7-year Treasury note?

Summary Introduction

To identify: The yield on the 7 year Treasury note.

Introduction:

Yield:

The percentage of the securities at which the company provides the return to its investors is a yield. Yield can be there in the form of dividend and interest.

Explanation

The items required for the calculation of actual yield on 7 year Treasury note are real risk-free rate, maturity risk premium, and inflation premium.

Compute the inflation premium

Given,

The inflation of current year is 3.05%.

Inflation of the next year is 4.75%.

Further inflation is 2.3%.

Formula to calculate the inflation premium for the 7 year,

Inflationpremium=(Inflationforthecurrentyear+Inflationforthenextyear+5(Inflationforthefurtheryears))7

Substitute 3.05% for inflation for current year, 4.75% for inflation for the next year and 2.3% inflation for the further years.

InflationPremium=(3.05%+4.75%+5(2.3%))7=3.05%+4.75%+11.5%7=19.3%7=2.76%

The inflation premium is 2

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