Answer the following questions:

* The real risk-free rate is 3 percent. Inflation is expected to be 2 percent this year and 4 percent during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?

* Default risk premium.

The real risk-free rate, r*, is 2.5 percent. Inflation is expected to average 2.8 percent a year for the next 4 years, after which time inflation is expected average 3.75 percent a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 8.3 percent, which includes a liquidity premium of 0.75 percent. What is its default risk premium?

* Heymann Company bonds have 4 years left to maturity. Interest is paid annually, and the bonds have a $1000 par value and a coupon rate of 9 percent.

a. What is the yield to maturity at a current market price of (1) $829 or (2) $1104?

b. Would you pay $829 for each bond if you thought that a “fair” market interest rate for such bonds was 12 percent – that is, if 4d = 12 percent? Explain your answer

* An 8 percent semiannual coupon bond matures in 5 years. The bond has a face value of $1000 and a current yield of 8.21 percent. What are the bond’s price and YTM?

**Subject Business Finance**