Introduction to Finance

217
a. 
If the expected real rate of interest is 3 percent, determine the 
infl ation premium on the Treasury bill.
b. 
If the maturity risk premium is expected to be zero, determine 
the infl ation premium on the Treasury note.
c. 
What is the expected infl ation premium for the second year?
12. 
A Treasury note with a maturity of four years carries a market rate 
of interest of 10 percent. In contrast, an eight-year Treasury note has 
a yield of 8 percent.
a. 
If infl ation is expected to average 7 percent over the fi rst four 
years, what is the expected real rate of interest?
b. 
If the infl ation rate is expected to be 5 percent for the fi rst year, 
calculate the average annual rate of infl ation for years 2 through 4.
c. 
If the maturity risk premium is expected to be zero between the 
two Treasury securities, what will be the average annual infl ation 
rate expected over years 5 through 8?
13. 
The interest rate on a 20-year Treasury bond is 9.25 percent. A 
comparable maturity, Aaa-rated corporate bond is yielding 10 percent. 
Another comparable maturity, but lower-quality corporate bond has a 
yield of 14 percent, which includes a liquidity premium of 1.5 percent.
a. 
Determine the default risk premium on the Aaa-rated bond.
b. 
Determine the default risk premium on the lower-quality corporate 
bond.
14. 
A 30-year corporate bond has a market interest rate of 12 percent. 
This bond is not very liquid and consequently requires a 2 percent 
liquidity premium. The bond is of low quality and thus has a default 
risk premium of 2.5 percent. The bond has a remaining life of 25 
years, resulting in a maturity risk premium of 1.5 percent.
a. 
Estimate the market interest rate on a 30-year Treasury bond.