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Tut Chapter 11 - Ans
Tut Chapter 11 - Ans
To determine the required rate of return, you must begin with the risk-free rate and add any
applicable risk premiums as shown below.
Risk-free rate 4.00 percent
Inflation risk premium 3.00 percent
Default risk premium 0.00 percent
Maturity risk premium 2.50 percent (10 years x 0.25)
Liquidity risk premium + 0.00 percent
Minimum yield required is 9.50 percent
6.
• Interest rate risk: Both
• Inflation risk: Both
• Business risk: Both
• Financial risk: Bonds
• Liquidity risk: Both
• Market risk: Both
• Political and regulatory risk: Both
• Exchange rate risk: Both
• Call risk: Bonds
Yes an investor would purchase the bond if primarily worried only about inflation risk as the
bond offers a positive real rate of return. The inflation rate would need to increase quite a
bit in order to negate all of the potential “real return” of each coupon.
9. a. Disposition Effect
b. Overconfidence
c. Herd Behavior