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Keys Corporation's 5-year bonds yield 6.50%, and 5-year T-bonds yield 4.40%. The real risk-free rate...

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Finance

  1. Keys Corporation's 5-year bonds yield 6.50%, and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the default risk premium for Keys' bonds is DRP = 0.40%, the liquidity premium on Keys' bonds is LP = 1.7% versus zero on T-bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on a 5-year bond?

    A.

    0.20%
    B.

    0.50%
    C.

    0.30%
    D.

    0.40%

  1. The real risk-free rate is 2%. The inflation rate is expected to be 3% a year for the next three years and then 4% a year thereafter. Assume that the default risk and liquidity premiums on all Treasury securities equal zero. You observe that 10-year Treasury bonds yield 1% more than the yield on 5-year Treasury bonds. What is the difference in the maturity risk premium on the two bonds? (That is, what is MRP10 - MRP5?) Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

    A.

    0.3%
    B.

    0.1%
    C.

    0.7%
    D.

    0.5%

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