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49.
Liquidity Premium Theory One-year Treasury bills currently earn 3.25 percent. You
expected that one year from now, one-year Treasury bill rates will increase to 3.45 percent
and that two years from now, one-year Treasury bill rates will increase to 3.95 percent.
The liquidity premium on two-year securities is 0.05 percent and on three-year securities
is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-
year Treasury securities?
50.
Liquidity Premium Theory One-year Treasury bills currently earn 2.95 percent. You
expected that one year from now, one-year Treasury bill rates will increase to 3.15 percent
and that two years from now, one-year Treasury bill rates will increase to 3.35 percent.
The liquidity premium on two-year securities is 0.05 percent and on three-year securities
is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-
year Treasury securities?
51.
Forecasting Interest Rates Assume the current interest rate on a one-year Treasury bond
(1
R
1) is 5.00 percent, the current rate on a two-year Treasury bond (1
R
2) is 5.75 percent,
and the current rate on a three-year Treasury bond (1
R
3) is 6.25 percent. If the unbiased
expectations theory of the term structure of interest rates is correct, what is the one-year
interest rate expected on Treasury bills during year 3, 3
f
1?
52.
Forecasting Interest Rates A recent edition of
The Wall Street Journal
reported interest
rates of 3.10 percent, 3.50 percent, 3.75 percent, and 3.95 percent for three-year, four-
year, five-year, and six-year Treasury security yields, respectively, According to the
unbiased expectation theory of the term structure of interest rates, what are the expected
one-year rates for year 6?
53.
A particular security's default risk premium is 3 percent. For all securities, the inflation risk
premium is 1.75 percent and the real interest rate is 4.2 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.
54.
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 one-year T-bills are
currently earning 3.55 percent. Your broker has determined the following information
about economic activity and Moore Corporation bonds:
Real interest rate = 2.75 percent
Default risk premium = 1.05 percent
Liquidity risk premium = 0.50 percent
Maturity risk premium = 1.85 percent
What is the inflation premium?
55.
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 one-year T-bills are
currently earning 3.55 percent. Your broker has determined the following information
about economic activity and Moore Corporation bonds:
Real interest rate = 2.75 percent
Default risk premium = 1.05 percent
Liquidity risk premium = 0.50 percent
Maturity risk premium = 1.85 percent
What is the fair interest rate on Moore Corporation 30-year bonds?
56.
Dakota Corporation 15-year bonds have an equilibrium rate of return of 9 percent. For all
securities, the inflation risk premium is 1.95 percent and the real interest rate is 3.65
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 bond's default risk
premium.
57.
A two-year Treasury security currently earns 5.13 percent. Over the next two years, the
real interest rate is expected to be 2.15 percent per year and the inflation premium is
expected to be 1.75 percent per year. Calculate the maturity risk premium on the two-year
Treasury security.
58.
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 = 5 percent, E(2r1) = 7 percent, E(3r1) = 7.5 percent E(4r1) = 7.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for one-
year and two-year -maturity Treasury securities.
59.
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 = 5 percent, E(2r1) = 6 percent, E(3r1) = 7.5 percent E(4r1) = 7.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for three-
year- and four-year-maturity Treasury securities.
60.
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 = 5 percent, E(2r1) = 6 percent, E(3r1) = 7.5 percent E(4r1) = 6.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for one-,
two-, three-, and four-year-maturity Treasury securities.
61.
One-year Treasury bills currently earn 3.75 percent. You expect that one year from now,
one-year Treasury bill rates will increase to 4.15 percent. If the unbiased expectations
theory is correct, what should the current rate be on two-year Treasury securities?
62.
One-year Treasury bills currently earn 4.5 percent. You expect that one year from now,
one-year Treasury bill rates will increase to 6.65 percent. The liquidity premium on two-
year securities is 0.05 percent. If the liquidity theory is correct, what should the current
rate be on two-year Treasury securities?
63.
Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity
premiums for the next four years are expected to be as follows:
R1 = 5.95 percent
E(r2) = 6.25 percent L2 = 0.05 percent
E(r3) = 6.75 percent L3 = 0.10 percent
E(r4) = 7.15 percent L4 = 0.12 percent
Using the liquidity premium hypothesis, what should be the current rate on four-year
Treasury securities?
64.
The Wall Street Journal
reports that the rate on three-year Treasury securities is 7.00
percent, and the six-year Treasury rate is 6.20 percent. From discussions with your broker,
you have determined that expected inflation premium is 2.25 percent next year, 2.50
percent in Year 2, and 2.50 percent in Year 3 and beyond. Further, you expect that real
interest rates will be 4.4 percent annually for the foreseeable future. Calculate the
maturity risk premium on the 3-year Treasury security.
65.
The Wall Street Journal
reports that the rate on three-year Treasury securities is 6.50
percent, and the six-year Treasury rate is 6.80 percent. From discussions with your broker,
you have determined that expected inflation premium is 2.25 percent next year, 2.50
percent in Year 2, and 2.60 percent in Year 3 and beyond. Further, you expect that real
interest rates will be 3.4 percent annually for the foreseeable future. Calculate the
maturity risk premium on the three-year and the six-year Treasury security.
66.
Nikki G's Corporation's 10-year bonds are currently yielding a return of 9.25 percent. The
expected inflation premium is 2.0 percent annually and the real interest rate is expected to
be 3.10 percent annually over the next 10 years. The liquidity risk premium on Nikki G's
bonds is 0.1 percent. The maturity risk premium is 0.10 percent on two-year securities and
increases by 0.05 percent for each additional year to maturity. Calculate the default risk
premium on Nikki G's 10-year bonds.
67.
Suppose we observe the following rates: 1R1 = 12 percent, 1R2 = 15 percent. If the
unbiased expectations theory of the term structure of interest rates holds, what is the
one-year interest rate expected one year from now, E(2r1)?
68.
The Wall Street Journal
reports that the rate on four-year Treasury securities is 7.50
percent and the rate on five-year Treasury securities is 9.15 percent. According to the
unbiased expectations hypotheses, what does the market expect the one-year Treasury
rate to be four years from today, E(5r1)?
69.
The Wall Street Journal
reports that the rate on three-year Treasury securities is 7.25
percent and the rate on four-year Treasury securities is 8.50 percent. The one-year
interest rate expected in three years is E(4r1), 4.10 percent. According to the liquidity
premium hypotheses, what is the liquidity premium on the four-year Treasury security, L4?
