# FIN 3400-A 2-year Treasury security currently earns 2.05 percent

Question
1. A 2-year Treasury security currently earns 2.05 percent. Over the next two years, the real risk-free rate is expected to be 1.00 percent per year and the inflation premium is expected to be 0.65 percent per year. Calculate the maturity risk premium on the 2-year Treasury security.

2. You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 1.60 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:

Real risk-free rate = 0.40%
Expected IP %
b.
What is the fair interest rate on Moore Corporation 30-year bonds? (Round your answer to 2 decimal places.)

3. Dakota Corporation 15-year bonds have an equilibrium rate of return of 9 percent. For all securities, the inflation risk premium is 1.80 percent and the real risk-free rate is 3.60 percent. The security’s liquidity risk premium is 0.90 percent and maturity risk premium is 1.50 percent. The security has no special covenants. Calculate the bond’s default risk premium

4. Tom and Sue’s Flowers, Inc.’s, 15-year bonds are currently yielding a return of 8.35 percent. The expected inflation premium is 2.35 percent annually and the real risk-free rate is expected to be 3.60 percent annually over the next 15 years. The default risk premium on Tom and Sue’s Flowers’ bonds is 0.60 percent. The maturity risk premium is 0.55 percent on 10-year securities and increases by 0.06 percent for each additional year to maturity. Calculate the liquidity risk premium on Tom and Sue’s Flowers, lnc.’s, 15-year bonds.

5. A particular security’s default risk premium is 4 percent. For all securities, the inflation risk premium is 3.65 percent and the real risk-free rate is 7.30 percent. The security’s liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the security’s equilibrium rate of return.

6. NikkiG’s Corporation’s 10-year bonds are currently yielding a return of 6.35 percent. The expected inflation premium is 1.05 percent annually and the real risk-free rate is expected to be 2.70 percent annually over the next ten years. The liquidity risk premium on NikkiG’s bonds is 0.55 percent. The maturity risk premium is 0.20 percent on 4-year securities and increases by 0.09 percent for each additional year to maturity. Calculate the default risk premium on NikkiG’s 10-year bonds.

7. The Wall Street Journal reports that the current rate on 9-year Treasury bonds is 5.90 percent, the rate on 16-year Treasury bonds is 6.30 percent, and the rate on a 16-year corporate bond issued by MHM Corp. is 7.45 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on an 9-year corporate bond issued by MHM Corp. are the same as those on the 16-year corporate bond, calculate the current rate on MHM Corp.’s 9-year corporate bond.

8. The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 7.85 percent, on 20-year Treasury bonds is 8.45 percent, and on a 20-year corporate bond issued by MHM Corp. is 9.95 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond issued by MHM Corp. are the same as those on the 20-year corporate bond, calculate the current rate on MHM Corp.’s 10-year corporate bond

9. Suppose that the current 1-year rate (1-year spot rate) and expected 1-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:
1R1 = 5%, E(2r1) = 6%, E(3r1) = 6.4%, E(4r1) = 6.75%
Using the unbiased expectations theory, calculate the current (long-term) rates for 1-, 2-, 3-, and 4-year-maturity Treasury securities. (Round your answers to 2 decimal places.)
Year Current (Long-term) Rates
1 %
2 %
3 %
4 %
10. Based on economists’ forecasts and analysis, 1-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:

R1 = .70%
E(2r1) = 1.85% L2 = 0.05%
E(3r1) = 1.95% L3 = 0.10%
E(4r1) = 2.25% L4 = 0.12%
Using the liquidity premium theory, plot the current yield curve. Make sure you label the axes on the graph and identify the four annual rates on the curve both on the axes and on the yield curve itself. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Year Current (Long-term) Rates
1 %
2 %
3 %
4
%