6-1.

YIELD CURVES

a. Plot a yield curve based on these data.

TERM RATE
6 months 4.69%
1 year 5.49% YIELD CURVE
2 years 5.66%
8.00%
3 years 5.71%
4 years 5.89% 7.00% 6.76%
6.64%
6.00% 6.05% 6.12%
5 years 6.05% 5.49% 5.66% 5.71% 5.89%
10 years 6.12% 5.00%
4.69%
20 years 6.64% 4.00%
30 years 6.76% 3.00%
2.00%
1.00%
0.00%
6 months 1 year 2 years 3 years 4 years 5 years 10 years 20 years 30 years

b. What type of yield curve is shown?

The yield curve is upward slopping.

c. What information does this graph tell you?

In general, rate of inflation is predicted to increase, and the maturity risk premium is expected to be highe

d. Based on this yield curve , if you needed to borrow money for longer than 1 year, would it make sense for you
to borrow short term and renew the loan or borrow long term? Explain.
In general, it makes sense to borrow for a short period of time because the interest rate will be lower each

6-2: REAL RISK-FREE RATE

You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.8%. Your brother-in-law, a broker at S
Securities, has given you thefollowing estimates of current interest rate premiums:
Given:
T-bill yield (rRF) = 5.8%
Inflation premium (IP) = 3.25%
Liquidity premium (LP) = 0.6%
Maturity risk premium (MRP) = 1.85%
Default risk premium (DRP) = 2.15%

On the basis of these data, what is the real risk-free rate of return?

rRF = r* + IP
5.8 % = r* + 3.25 %
5.8 % - 3.25 % = r*
r= 2.55%

The real risk-free of return is 2.55%.

 6.64% 6.76%
%

ars 20 years 30 years

ium is expected to be higher than zero.

ould it make sense for you

erest rate will be lower each year.

brother-in-law, a broker at Safe and Sound