1. The real risk-free rate of interest is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-yr and 3-yr U.S. Treasury bonds? (Hint: for U.S. Treasury bonds, DRP = LP = 0) (Show work)
2. The real risk-free rate is 3% and inflation is expected to be 3% for the next 2 years. A 2-yr U.S. Treasury bond yields 6.2%. What is the MRP on the 2-yr treasury? (Show work)
3. A U.S. Treasury bond that matures in 10 years has a yield of 6%. A 10-yr corporate bond has a yield of 8%. Assume the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond? (Hint: since both bonds have the same maturity, they will have the same MRP) (Show work)
4. The real risk-free rate is 3%. Inflation is expected to be 3% this year, 4% next year and 3.5% thereafter. The MRP is estimated to be 0.05%(t – 1) where t is the number of years to maturity. What is the nominal interest rate on a 7-yr U.S. Treasury bond? (Show work)
5. You own a corporate bond that currently has a fair market value of $1023.68. If you sold this bond for $1,050.00, what would your rate of return be? (Note: face value ≠ fair market value; use profit/investment) (Show work)
6. You are considering purchasing one of the following securities: Security A: Sales Price = $10,300.00 Fair Market Value (FMV) = $10,192.56 Security B: Sales Price = $1,200.00 Fair Market Value (FMV) = $1,182.05 Which security is most fairly priced? [Hint: the most fairly priced security is the one that offers its seller the smallest rate of profit] (Show work)