1. the Real Risk-Free Rate Is 3 Percent. Inflation Is Expected to Be 3 Percent This Year

Monday, February 26, 2007

Chapter 6

1. The real risk-free rate is 3 percent. Inflation is expected to be 3 percent this year, 4 percent next year, and then 3.5 percent thereafter. The maturity risk premium is estimated to be 0.05 X (t-1)%, where t = number of years to maturity. What is the yield on a 7-year Treasury note?

2. Due to a recession, expected inflation this year is only 3 percent. However, the inflation rate in year 2 and thereafter is expected to be constant at some level above 3 percent. Assume that the expectations theory holds and the real risk-free rate is r* = 2%. If the yield on 3-year treasury bonds equals the 1-year yield plus 2 percent, what inflation rate is expected after year 1?

3. An investor in Treasury securities expects inflation to be 2.5 percent in Year 1, 3.2 percent in Year 2, and 3.6 percent each year thereafter. Assume that the real risk-free rate is 2.75 percent, and that this rate will remain constant. Three-year Treasury securities yield 6.25 percent, while 5-year Treasury securities yield 6.80 percent. What is the difference in the maturity risk premiums (MRPs) on the two securities (MRP5 – MRP3)?

Chapter 7

1. What are the four types of bonds?

2. A bond has a $1,000 par value, 10 years to maturity, a 7 percent annual coupon, and sells for $985

a. What is its current yield?

b. What is its yield to maturity?

c. Assume that the YTM remains constant for the next 3 years. What will the price be 3-years from today?

3. Six years ago, the Singleton Company issues 20-year bonds with a 14 percent annual coupon at their $1,000 par value. The bonds had a 9 percent call premium, with 5 years of call protection. Today, Singleton calld the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called.

4. An 8 percent semiannual coupon bond matures in 5 years. The bond has a face value of $1,000 and a current yield of 8.21 percent. What are the bond’s price and YTM?

5. A semiannual coupon bond that matures in 7 years sells for $1,020. It has a face value of $1,000 and a YTM of 10.5883 percent. What is its current yield?