Discuss what bond yield spreads are and why they exist. How do these spreads ten

Question

Discuss what bond yield spreads are and why they exist. How do these spreads tend to vary over the business cycle (i.e. during recessions and expansions)? Why is this? (3 pts.)

If the real risk-free rate of interest is 2.8 % and inflation is expected to be 3% in the coming year, 5% in the second year, 6% in the third year, and 3% per year for the next three years after that, what rate of return would you expect on a 6-year Treasury bond if the maturity risk premium is equal to %0.12 per year of maturity. (2 pts.)

Explanation / Answer

  r6 = r* + IP + MRP

            r6 = 2.8 + ((3+5+6+3+3+3)/6) + 0.12

            r6 = 2.8%+3.67%+0.12%

= 6.59%

in this r6 = return of 6 years treasury bond

r= risk free rate

ip average inflation

mrp= market risk premium

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