The real risk-free rate is 2.25%. Inflation is expected to be 2.5% this year and 4.25% 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?

A Treasury bond that matures in 10 years has a yield of 5.75%. A 10-year corporate bond has a yield of 8.75%. Assume that the liquidity premium on the corporate bond is 0.35%. What is the default risk premium on the corporate bond?

Assume that yields on U.S. Treasury securities were as follows: $$ \begin{matrix} \text{Term} & \text{Rate}\\ \text{6 monts} & \text{4.69 \\%}\\ \text{1 year} & \text{5.49}\\ \text{2 years} & \text{5.66}\\ \text{3 years} & \text{5.71}\\ \text{4 years} & \text{5.89}\\ \text{5 years} & \text{6.05}\\ \text{10 years} & \text{6.12}\\ \text{20 years} & \text{6.64}\\ \text{30 years} & \text{6.73}\\ \end{matrix} $$ a. Plot a yield curve based on these data. b. What type of yield curve is shown? c. What information does this graph tell you? d. Based on this yield curve, if you needed to borrow money for longer than 1 year, would it make sense for you to borrow short term and renew the loan or borrow long term? Explain.

One-year Treasury securities yield 4.85%. The market anticipates that 1 year from now, 1-year Treasury securities will yield 5.2%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury securities? Calculate the yield using a geometric average.

Assume that the real risk-free rate is 2% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2? Calculate this yield using a geometric average. What inflation rate is expected during Year 2? Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2.

Due to a recession, expected inflation this year is only 3.25%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3.25%. Assume that the expectations theory holds and the real risk-free rate $\left(\mathrm{r}^{*}\right)$ is 2.5%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 1.5%, what inflation rate is expected after Year 1?

You read in The Wall Street Journal that $30$-day T-bills are currently yielding $5.5 \%$. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

• Inflation premium $=3.25 \%$

• Liquidity premium $=0.6 \%$

• Maturity risk premium $=1.8 \%$

• Default risk premium $=2.15 \%$

On the basis of these data, what is the real risk-free rate of return?

A company’s 5-year bonds are yielding 7% per year. Treasury bonds with the same maturity are yielding 5.2% per year, and the real risk-free rate $\left(\mathrm{r}^{*}\right)$ is 2.75%. The average inflation premium is 2.05%; and the maturity risk premium is estimated to be $0.1 \times(t-1) \%$, where t=number of years to maturity. If the liquidity premium is 0.7%, what is the default risk premium on the corporate bonds?

Interest rates on 4-year Treasury securities are currently 6.7%, while 6-year Treasury securities yield 7.25%. If the pure expectations theory is correct, what does the market believe that 2-year securities will be yielding 4 years from now? Calculate the yield using a geometric average.

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 18% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk?

Suppose 2-year Treasury bonds yield 4.1%, while 1-year bonds yield 3.2%. $\mathbf{r}^{*}$ is 1%, and the maturity risk premium is zero. a. Using the expectations theory, what is the yield on a 1-year bond 1 year from now? Calculate the yield using a geometric average. b. What is the expected inflation rate in Year 1? Year 2?

Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average company’s common stock?

The real risk-free rate, $r^{*}$, is 1.7%. Inflation is expected to average 1.5% a year for the next 4 years, after which time inflation is expected to average 4.8% a year. Assume that there is no maturity risk premium. An 11-year corporate bond has a yield of 8.7%, which includes a liquidity premium of 0.3%. What is its default risk premium?

An investor in Treasury securities expects inflation to be risk-free rate is 1.95% and that this rate will remain constant. Three-year Treasury securities yield 5.20%, while 5-year Treasury securities yield 6.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is $\mathrm{MRP}_{5}-\mathrm{MRP}_{3} ?$