E m F 2 years 4 years 4% B D 1 Interest Rate Determination and Yield Curves 2. 3 b. Finding the yield for each of the two investments 4 Real risk-free rate 3% 5 Expected inflation 2% for the next 6 Expected inflation 3% for the following 7 Expected inflation thereafter 8 Maturity risk premium = 0.02% *(t-1) 9 Liquidity premium 0.2% 10 Maturity of treasury bond 12 years 11 Maturity of corporate bond 7 years 12 Corporate bond rating A 13 14 12-year Treasury Bond Formulas 15 Real risk-free rate #NA 16 Inflation premium #N/A 17 Maturity risk premium #NA 18 12-year Treasury yield #N/A 19 20 Rating DRP + LP 21 AAA 0.10% 22 AA 0.44% 23 A 0.78% 24 25 7-year Corporate Bond 26 Real risk-free rate #N/A 27 Inflation premium #N/A 28 Maturity risk premium #N/A 29 Liquidity premium #NA 30 Default risk premium #N/A 31 7.yoor corporate yield #NA 32 33 c. Constructing a graph of the yield curve 34 35 Years to Maturity Yield 1 5.42% 37 5.47% 38 3 5.64% 39 5.71% 40 5 5.62% 41 5.76% 42 20 6.38% 43 30 5.93% 36 2 CAN 4 10 44 A B c F 56 57 58 59 80 61 62 63 64 d. Calculating yields and then constructing a new yield curve graph that shows both the Treasury and the corporate bonds Treasury A-Corporate 67 Years yield yield Spread LP DRP 68 5.42% 69 5.47% 70 5.64% 71 5.71% 72 5.62% 73 10 5.76% 74 20 6.38% 75 30 5.93% 65 66 WN 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 t. Calculating the rates using geometric averages 97 (1) Calculating the 1-year rate, 1 year from now 98 (2) Calculating the 5-year rate, 5 years from now 99 (3) Calculating the 10-year rate, 10 years from now 100 (4) Calculating the 10-year rate, 20 years from now Formulas #N/A NA #NA #NA E m F 2 years 4 years 4% B D 1 Interest Rate Determination and Yield Curves 2. 3 b. Finding the yield for each of the two investments 4 Real risk-free rate 3% 5 Expected inflation 2% for the next 6 Expected inflation 3% for the following 7 Expected inflation thereafter 8 Maturity risk premium = 0.02% *(t-1) 9 Liquidity premium 0.2% 10 Maturity of treasury bond 12 years 11 Maturity of corporate bond 7 years 12 Corporate bond rating A 13 14 12-year Treasury Bond Formulas 15 Real risk-free rate #NA 16 Inflation premium #N/A 17 Maturity risk premium #NA 18 12-year Treasury yield #N/A 19 20 Rating DRP + LP 21 AAA 0.10% 22 AA 0.44% 23 A 0.78% 24 25 7-year Corporate Bond 26 Real risk-free rate #N/A 27 Inflation premium #N/A 28 Maturity risk premium #N/A 29 Liquidity premium #NA 30 Default risk premium #N/A 31 7.yoor corporate yield #NA 32 33 c. Constructing a graph of the yield curve 34 35 Years to Maturity Yield 1 5.42% 37 5.47% 38 3 5.64% 39 5.71% 40 5 5.62% 41 5.76% 42 20 6.38% 43 30 5.93% 36 2 CAN 4 10 44 A B c F 56 57 58 59 80 61 62 63 64 d. Calculating yields and then constructing a new yield curve graph that shows both the Treasury and the corporate bonds Treasury A-Corporate 67 Years yield yield Spread LP DRP 68 5.42% 69 5.47% 70 5.64% 71 5.71% 72 5.62% 73 10 5.76% 74 20 6.38% 75 30 5.93% 65 66 WN 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 t. Calculating the rates using geometric averages 97 (1) Calculating the 1-year rate, 1 year from now 98 (2) Calculating the 5-year rate, 5 years from now 99 (3) Calculating the 10-year rate, 10 years from now 100 (4) Calculating the 10-year rate, 20 years from now Formulas #N/A NA #NA #NA