Reference no: EM132396611
Suppose the inflation rate is expected to be 6.3% next year, 4% the following year, and 3.5% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds.
a. Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places.
b. Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places
c. Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places.
d. Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places.
e. Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places.
f. Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places.
g. Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places.
Suppose a AAA-rated company (which is the highest bond rating a firm can have) had bonds with the same maturities as the Treasury bonds. Estimate what you believe a AAA-rated company's yield curve would look like on the same graph with the Treasury bond yield curve. (Hint: Think about the default risk premium on its long- term versus its short-term bonds.)
- The yield risk curve for the AAA-rated corporate bonds will (rise above, fall below, be the same) as the yield curve for the Treasury securities.
- What will be the approximate yield curve of a much riskier lower-rated company with a much higher risk of defaulting on its bonds?
The yield risk curve of a much riskier lower-rated company will be (above, below, the same) as the yield curve for the Treasury securities and (above, below, the same) as the yield curve for the AAA-rated corporate bonds.