Question
PLEASE ANSWER BOTH QUESTIONS 1. The real risk-free rate (r*) is 2.80% and is expected to remain constant into the future. Inflation is expected to
PLEASE ANSWER BOTH QUESTIONS
1. The real risk-free rate (r*) is 2.80% and is expected to remain constant into the future. Inflation is expected to be 6.80% per year for each of the next two years and 5.60% thereafter.
The maturity risk premium (MRP) is determined from the formula: 0.10 x (t 1)%, where t is the securitys maturity. The liquidity premium (LP) on all National Transmissions Corp.s bonds is 1.20%. 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% |
National Transmissions Corp. issues thirteen-year, AA-rated bonds. What is the yield on one of these bonds? (Hint: Disregard cross-product terms; that is, if averaging is required, use an arithmetic average.)
10.58%
11.78%
6.00%
2. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?
A) The yield on a AAA-rated bond will be lower than the yield on a AA-rated bond.
B) The yield on a AAA-rated bond will be higher than the yield on a BB-rated bond.
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