Click here to read the eBook: The Maturity Risk Premium (MRP) Problem 5-19 Matur
ID: 2776779 • Letter: C
Question
Click here to read the eBook: The Maturity Risk Premium (MRP)
Problem 5-19
Maturity Risk Premiums
Assume that the real risk-free rate, r*, is 4% and that inflation is expected to be 8% in Year 1, 6% in Year 2, and 4% thereafter. Assume also that all Treasury securities are highly liquid and free of default risk. If 2-year and 5-year Treasury notes both yield 10%, what is the difference in the maturity risk premiums (MRPs) on the two notes; that is, what is MRP5 minus MRP2? Round your answer to two decimal places.
%
Explanation / Answer
yield on 2yr bond
r = real risk free rate + Inflation Premium + Market risk premium
10 = 4 + ((8+6)/2) + MRP2
MRP2= -1
yield on 5yr bond
r = real risk free rate + Inflation Premium + Market risk premium
10 = 4 + ((8+6 + 4+ 4+4)/5) + MRP5
MRP5 = 0.8
MRP5 - MRP2 = 0.8 - (-1) = 1.8%
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