Introduction to Finance

a. 
Estimate the expected real rate of return on the 10-year U.S. 
Treasury note.
b. 
If the real rate of return is expected to be the same for the 30-
year bond as for the 10-year note, estimate the average annual infl a-
tion rate expected by investors over the life of the 30-year bond.
6. 
You are considering an investment in a one-year government debt 
security with a yield of 5 percent or a highly liquid corporate debt 
security with a yield of 6.5 percent. The expected infl ation rate for the 
next year is expected to be 2.5 percent.
a. 
What would be your real rate earned on either of the two 
investments?
b. 
What would be the default risk premium on the corporate debt 
security?
7. 
Infl ation is expected to be 3 percent over the next year. You desire 
an annual real rate of return of 2.5 percent on your investments.
a. 
What market rate of interest would have to be off ered on a one-
year Treasury security for you to consider making an investment?
b. 
A one-year corporate debt security is being off ered at two per-
centage points over the one-year Treasury security rate that meets 
your requirement in (a). What would be the market interest rate on 
the corporate security? 
8. 
Find the market interest rate for a debt security given the following 
information: real rate = 2 percent, liquidity premium = 2 percent, 
default risk premium = 4 percent, maturity risk premium = 3 percent, 
and infl ation premium = 3 percent.
9. 
Find the default risk premium for a debt security given the fol-
lowing information: infl ation premium = 3 percent, maturity risk 
premium = 2.5 percent, real rate = 3 percent, liquidity premium = 0 
percent, and market interest rate = 10 percent.
10. 
Find the default risk premium for a debt security given the fol-
lowing information: infl ation premium = 2.5 percent, maturity risk 
premium = 2.5 percent, real rate = 3 percent, liquidity premium = 1.5 
percent, and market interest rate = 14 percent.
11. 
Assume that the interest rate on a one-year Treasury bill is 6 per-
cent and the rate on a two-year Treasury note is 7 percent.

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Problems