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b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, AA-rated corporate bond. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0.03(t-1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.2%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRP. U.S. Treasury AAA corporate AA corporate A corporate Rate 0.83% 1.03 1.43 1.85 Corporate Bond Yield Spread = DRP + LP What yield would you predict for each of these two investments? Round your answers to three decimal places. 12-year Treasury yield: 7-year Corporate yield: % 0.20% 0.60 1.02 % c. Given the following ireasury Dona yieia information, construct a grapn or the yiela curve. Maturity 1 year 2 years 3 years 4 years 5 years 10 years 20 years 30 years Choose the correct graph. The correct graph is A. C. Interest Rate 8% 7%- 6% + 5% 4% 3% 2% 1% 0% 8% 7%- 6% 5% 4% 3% 2% 1% Yield 5.32% 5.42 5.62 5.69 5.60 5.71 6.27 5.86 0%- 5 5 10 10 Yield Curve 15 Years to Maturity Yield Curve 20 15 Years to Maturity 20 25 25 30 30 B. D. 8% 7%- 6% 5% 4% 3% 2%- 1% 0%- 8% 7% 6% Interest Rate 25% 4% 3% 2% 1%- 0% 5 5 10 10 Yield Curve 15 Years to Maturity 20 Yield Curve 15 Years to Maturity 20 25 25 30 30 d. Based on the information about the corporate bond provided in part b, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds. Round your answers to two decimal places. A. Years C. 1 2 3 4 5 10 20 30 Choose the correct graph. The correct graph is 8% 7%- 6% 5% 4% 3%- 2%- 1% - 0% + 8% 7%- 6%- 5%- 3% 2% 1% Treasury yield 0% 5.32% 5.42% 5.62% 5.69% 5.60% 5.71% 6.27% 5.86% 5 AA-corporate yield % % % % % % % % Treasury and Corporate Yield Curves 15 10 Years to Maturity Treasury bond 20 25 Corporate bond Treasury and Corporate Yield Curves 30 B. D. 8% 7%- 5%- wterest Rat 4% 3%- 2%- 1%- 0% + 8% 7% 6% 5% 4%- 3%- 2% 1%- 0%- 5 Treasury and Corporate Yield Curves 15 10 Years to Maturity Treasury bond 20 25 Corporate bond Treasury and Corporate Yield Curves 30 e. Which part of the yield curve (the left side or right side) is likely to be most volatile over time? volatile than longer-term rates; therefore, the side of the yield curve would be most volatile over time. f. Using the Treasury yield information in part c, calculate the following rates using geometric averages (round your answers to three decimal places): 1. The 1-year rate, 1 year from now Short-term rates are % 2. The 5-year rate, 5 years from now % 3. The 10-year rate, 10 years from now % 4. The 10-year rate, 20 years from now % b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, AA-rated corporate bond. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0.03(t-1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.2%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRP. U.S. Treasury AAA corporate AA corporate A corporate Rate 0.83% 1.03 1.43 1.85 Corporate Bond Yield Spread = DRP + LP What yield would you predict for each of these two investments? Round your answers to three decimal places. 12-year Treasury yield: 7-year Corporate yield: % 0.20% 0.60 1.02 % c. Given the following ireasury Dona yieia information, construct a grapn or the yiela curve. Maturity 1 year 2 years 3 years 4 years 5 years 10 years 20 years 30 years Choose the correct graph. The correct graph is A. C. Interest Rate 8% 7%- 6% + 5% 4% 3% 2% 1% 0% 8% 7%- 6% 5% 4% 3% 2% 1% Yield 5.32% 5.42 5.62 5.69 5.60 5.71 6.27 5.86 0%- 5 5 10 10 Yield Curve 15 Years to Maturity Yield Curve 20 15 Years to Maturity 20 25 25 30 30 B. D. 8% 7%- 6% 5% 4% 3% 2%- 1% 0%- 8% 7% 6% Interest Rate 25% 4% 3% 2% 1%- 0% 5 5 10 10 Yield Curve 15 Years to Maturity 20 Yield Curve 15 Years to Maturity 20 25 25 30 30 d. Based on the information about the corporate bond provided in part b, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds. Round your answers to two decimal places. A. Years C. 1 2 3 4 5 10 20 30 Choose the correct graph. The correct graph is 8% 7%- 6% 5% 4% 3%- 2%- 1% - 0% + 8% 7%- 6%- 5%- 3% 2% 1% Treasury yield 0% 5.32% 5.42% 5.62% 5.69% 5.60% 5.71% 6.27% 5.86% 5 AA-corporate yield % % % % % % % % Treasury and Corporate Yield Curves 15 10 Years to Maturity Treasury bond 20 25 Corporate bond Treasury and Corporate Yield Curves 30 B. D. 8% 7%- 5%- wterest Rat 4% 3%- 2%- 1%- 0% + 8% 7% 6% 5% 4%- 3%- 2% 1%- 0%- 5 Treasury and Corporate Yield Curves 15 10 Years to Maturity Treasury bond 20 25 Corporate bond Treasury and Corporate Yield Curves 30 e. Which part of the yield curve (the left side or right side) is likely to be most volatile over time? volatile than longer-term rates; therefore, the side of the yield curve would be most volatile over time. f. Using the Treasury yield information in part c, calculate the following rates using geometric averages (round your answers to three decimal places): 1. The 1-year rate, 1 year from now Short-term rates are % 2. The 5-year rate, 5 years from now % 3. The 10-year rate, 10 years from now % 4. The 10-year rate, 20 years from now %
