1. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7 year, A-rated corporate bond. The current real risk-free rate is 4 percent, and inflammation is expected to be 2 percent for the next two years, 3 percent for the following 4 years, and 4 percent thereafter. The maturity risk premium is estimated by this formula: MRP = 0.1% (t - 1). The liquidity premium for the corporate bond is estimated to be 0.7 percent. Finally, you may determine the default risk premium, given the company's bond rating, from the default risk premium table in the text. What yield would you predict for each of these two investments?
2. Given the following Treasury bond yield information from the March 27, 2003, Federal Reserve Statistical Release, construct a graph of the yield curve as of that date.
Maturity Yield
3 months 1.16 %
6 months 1.17
1 year 1.25
2 years 1.62
3 years 2.05
5 years 2.92
7 years 3.50
10 years 3.95
20 years 4.96
3. Based on the information about the corporate bond that was given in part a, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds.