Interest rate model and bond valuation
1. As per economist, if savings equal $5 trillion and spending equals $100 trillion, what will investment equal?
2. Inflation is expected to be 3.0% this year, 4.0% next year, 5.0% in year 3 and a steady 4.0% after that. The Pure Interest Rate is 2.5%. The Liquidity Risk Premium is zero for corporate bonds under three years and 0.5% for bonds with terms of three years or more. The Default Risk Premium is 1.0% for corporate bonds. The Maturity Risk Premium is find outd by using the following formula: 0.2 %( t-1), where t = the term of the bond. Using the Interest Rate Model, develop the term structure for a corporate bond and for a federal government bond for bonds with terms of 1 through 10 years.
3. If inflation is expected to be 3.0% per year for the next three years and 4.0% per year thereafter, and the real risk free rate is estimated to be 2.4%, find out the base rate component for each of the following securities: 4-year; 6-year; 10-year.
4. If inflation is not expected to change from its current level for the foreseeable future, would you expect to see a normal or an inverted yield curve for a series of bonds issued by a stable corporation?Why?