ter 5: Rat he after-tax is affected by yield constant. d to be offered -free rate. d to be offered ault risk pre- ship. by issuing would help in my on 10-year that would its 10-year by issuing loans onths, explain ting the yield it s. That is, what the rate Carson gests that the arge on a long- n the initial rate accordance with WSJ EXERCISE Interpreting the Structure of Interest Rates a. Explaining Yield Differentials Using the most recent issue of the Wall Street Journal, review the yields for the following securities: TYPE MATURITY YIELD Treasury 10-year Corporate: high-quality 10-year Corporate: medium-quality 10-year Municipal (tax-exempt) 10-year If credit (default) risk is the only reason for the yield differentials, then what is the default risk premium on the corporate high-quality bonds? On the medium- quality bonds? During a recent recession, high-quality corporate bonds offered a yield of 0.8 percent above Treasury bonds while medium-quality bonds offered a yield of about 3.1 percent above Treasury bonds. How do these yield differentials compare to the differentials today? Explain the reason for any change. Using the information in the previous table, complete the following table. In Column 2, indicate the before-tax yield necessary to achieve the existing after-tax yield of tax-exempt bonds. In Column 3, answer this question: If the tax-exempt bonds have the same risk and other type of features as high-quality corporate bonds, which bond is preferable for investors in each tax bracket? MARGINAL TAX BRACKET OF INVESTORS EQUIVALENT BEFORE TAX YIELD PREFERRED BOND y that creditors e loan to offering 10% Carson's expec- 15% ecessarily the 20% ons. 28% 34% b. Examining Recent Adjustments in Cr Risk Using the most recent issue of the Wall Street Journal, review the corporate debt section showing the high-yield issue with the biggest p decrease. you Why do think there was such a large decrease in price? How does this decrease in price affect the expected yield for any investors who buy now? c. Determining and Interpreting Today Structure Using the most recent issue of the Wall Street Journal, review the yield curve to determine the approximate yields for the follo maturities: TERM TO MATURITY ANNUALIZED YI 1 year 2 years 3 years Assuming that the differences in these y are due solely to interest rate expectations, c the forward rate as of one year fro one-year and the one-year forward rate as of two yea from now. d. The Wall Street Journal provides a Yield Curve." Use this curve to describe the expectations about future interest rates. If a premium exists, how would this affect your of the market's expectations? mpting to ould explain the -day Treasury hich theory, in Why?