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12 #3 3. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7%
12 #3
3. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 7% per year for each of the next five years and 6% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t-1) %, where t is the security's maturity. The liquidity premium (LP) on all Pandar Corp.'s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury AAA 0.60% AA 0.80% A 1.05% BBB 1.45% Pandar Corp. issues 7-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. 11.46% 4.75% 10.91% 10.86% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? An AAA-rated bond has less default risk than a BB-rated bond. The yield on an AAA-rated bond will be higher than the yield on a BB-rated bondStep by Step Solution
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