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18.  Problem 6.17 INTEREST RATE PREMIUMS A 5-year Treasury bond has a 3.35% yield. A 10-year Treasury...

18.  Problem 6.17

INTEREST RATE PREMIUMS

A 5-year Treasury bond has a 3.35% yield. A 10-year Treasury bond yields 6.25%, and a 10-year corporate bond yields 9.55%. The market expects that inflation will average 3.15% over the next 10 years (IP10 = 3.15%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described. What is the yield on this 5-year corporate bond? Round your answer to two decimal places.

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Answer #1

yield on this 5-year corporate bond = 10-year corporate bond yield-10-year Treasury bond yield+5-year Treasury bond

=9.55-6.25+3.35 = 6.65%

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