A one-year Treasury bill currently offers a 5% rate of return. A two-year Treasury note offers a 5.5% rate of return. Under the expectations theory, what rate of return do investors expect a one-year Treasury bill to pay next year?

P6-17 Asset valuation and risk Laura Drake wishes to estimate the value of an asset expected to provide cash inflows of $3,000 per year for each of the next four years and $15,000 in five years. Her research indicates that she must earn 4% on low-risk assets, 7% on average-risk assets, and 14% on high-risk assets.

2. Determine what is the most Laura should pay for the asset if it is classified as (1) low-risk, (2) average-risk, and (3) high-risk.
4. Suppose that Laura is unable to assess the risk of the asset and wants to be certain she's making a good deal. On the basis of your findings in part a, what is the most she should pay? Why?
6. All else being the same, what effect does increasing risk have on the value of an asset? Explain your answer in light of your findings in part a

P6-31 Bond valuation and yield to maturity Mark Goldsmith's broker has shown him two bonds issued by different companies. Each has a maturity of five years, a par value of $1,000, and a yield to maturity of 7.5%. The first bond is issued by Crabbe Waste Disposal Corporation and has a coupon rate of 6.324% paid annually. The second bond, issued by Malfoy Enterprises, has a coupon rate of 8.8% paid annually.

• Calculate the selling price for each bond.
• Mark has $20,000 to invest. If he wants to invest only in bonds issued by Crabbe Waste Disposal, how many of those bonds could he buy? What if he wants to invest only in bonds issued by Malfoy Enterprises? Round your answers to the nearest integer.
• What is the total interest income that Mark could earn each year if he invested only in Crabbe bonds? How much interest would he earn each year if he invested only in Malfoy bonds?
• Assume that Mark will reinvest all the interest he receives as it is paid, and his rate of return on reinvested interest will be 10%. Calculate the total dollars that Mark will accumulate over five years if he invests in Crabbe bonds or Malfoy bonds. Your total dollar calculation will include the interest Mark gets, the principal he receives when the bonds mature, and all the additional interest he earns from reinvesting the coupon payments that he receives.
• The bonds issued by Crabbe and Malfoy might appear to be equally good investments because they offer the same yield to maturity of 7.5%. Notice, however,
• hat your answers to part d are not the same for each bond, suggesting that one bond is a better investment than the other. Why is that the case?

P7-26 ETHICS PROBLEM Melissa is trying to value the stock of Generic Utility Inc., which is clearly not growing at all. Generic declared and paid a $5 dividend last year. The required return for utility stocks is 11%, but Melissa is unsure about the financial reporting integrity of Generic's finance team. She decides to add an extra 1% "credibility" risk premium to the required return as part of her valuation analysis.

2. What is the value of Generic's stock, assuming that the financials are trustworthy?
4. What is the value of Generic's stock, assuming that Melissa includes the extra 1% "credibility" risk premium?
6. What is the difference between the values found in parts a and b, and how might one interpret that difference?

C