Problem 6-3 Expected Interest Rate

A) The real risk-free rate is 2.75%. Inflation is expected to be 1.75% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero.

What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. %

B) What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. %

Expected Interest Rate

C) The real risk-free rate is 2.85%. Inflation is expected to be 2.2% this year, 4.6% next year, and 2.15% thereafter. The maturity risk premium is estimated to be 0.05(t - 1)%, where t = number of years to maturity. What is the yield on a 7-year Treasury note? Do not round your intermediate calculations. Round your answer to two decimal places.

%

Default Risk Premium

D) A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 8.5%. Assume that the liquidity premium on the corporate bond is 0.55%. What is the default risk premium on the corporate bond? Round your answer to two decimal places.

%

Maturity Risk Premium

E) The real risk-free rate is 3.25%, and inflation is expected to be 2% for the next 2 years. A 2-year Treasury security yields 8.25%. What is the maturity risk premium for the 2-year security? Round your answer to two decimal places.

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Real Risk-Free Rate

F) You read in The Wall Street Journal that 30-day T-bills are currently yielding 4.8%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

Inflation premium = 2.5%

Liquidity premium = 1.1%

Maturity risk premium = 2%

Default risk premium = 2.75%

On the basis of these data, what is the real risk-free rate of return? Round your answer to two decimal places.

%