Question 3 a) Suppose that the current one-year spot rate and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 6.60%, E(2r1) = 7.55%, E(3r1) = 8.15%, E(4r1) = 8.40%. We additionally expect that liquidity premiums for years 2, 3 and 4 are as follows: L2 = 0.20%, L3 = 0.30%, L4 = 0.40%. Using the liquidity premium theory, calculate the current long-term rates for one-two-, three-, and four-year-maturity Treasury securities and plot the current yield curve. Please show each step of your calculation. [14 marks] b) Suppose the consumer price index is 97.50 in 2019 and 99.30 in 2020, what is the inflation from 2019 to 2020? Please show each step of your calculation. [3 marks] c) A particular security's equilibrium rate of return is 7.90%. For all securities, the inflation risk premium is 2.10% and the real risk-free rate is 3.65%. The security's liquidity risk premium is 0.35% and maturity risk premium is 0.95%. The security has no special covenants. Calculate the security's default risk premium. Please show each step of your calculation. [4 marks] d) Special provision is one factor that determines the interest rates for individual securities. Please discuss the impact of three important special provisions on interest rates. [9 marks] [Total marks: 30 marks] Question 3 a) Suppose that the current one-year spot rate and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 6.60%, E(2r1) = 7.55%, E(3r1) = 8.15%, E(4r1) = 8.40%. We additionally expect that liquidity premiums for years 2, 3 and 4 are as follows: L2 = 0.20%, L3 = 0.30%, L4 = 0.40%. Using the liquidity premium theory, calculate the current long-term rates for one-two-, three-, and four-year-maturity Treasury securities and plot the current yield curve. Please show each step of your calculation. [14 marks] b) Suppose the consumer price index is 97.50 in 2019 and 99.30 in 2020, what is the inflation from 2019 to 2020? Please show each step of your calculation. [3 marks] c) A particular security's equilibrium rate of return is 7.90%. For all securities, the inflation risk premium is 2.10% and the real risk-free rate is 3.65%. The security's liquidity risk premium is 0.35% and maturity risk premium is 0.95%. The security has no special covenants. Calculate the security's default risk premium. Please show each step of your calculation. [4 marks] d) Special provision is one factor that determines the interest rates for individual securities. Please discuss the impact of three important special provisions on interest rates. [9 marks] [Total marks: 30 marks]
