Chapter 2 - Questions PDF

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Chapter 2: 1. A particular security’s equilibrium rate of return is 8 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 3.5 percent. The security’s liquidity risk premium is .25 percent and maturity risk premium is .85 percent. The security has no special covenants. Calculate the security’s default risk premium. 2. Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1

= 6%, E(2R1)=7%, E(3R1)=7.5%, E(4R1)=7.85%,

Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. Plot the resulting yield curve. 3. A recent edition of The Wall Street Journal reported interest rates of 2.25 percent, 2.60 percent, 2.98 percent, and 3.25 percent for three-year, four-year, five-year, and six-year Treasury note yields, respectively. According to the unbiased expectations theory of the term structure of interest rates, what are the expected one-year rates during years 4, 5, and 6? 4. Suppose we observe the following rates: 1R1=10, 1R2=.14, and E(2R1)=10. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2?

5. If you note the following yield curve in The Wall Street Journal, what is the one-year forward rate for the period beginning one year from today, 2f1 according to the unbiased expectations hypothesis? Maturity

Yield

One day One year

2.00% 5.50

Two years

6.50

Three years

9.00...