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Inflation Premium

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA FM Exams › Inflation Premium

  • This topic has 4 replies, 2 voices, and was last updated 11 years ago by csacct1.
Viewing 5 posts - 1 through 5 (of 5 total)
  • Author
    Posts
  • April 12, 2014 at 6:18 am #165090
    csacct1
    Member
    • Topics: 14
    • Replies: 19
    • ☆

    Hi Sir,

    Crockett Corporation’s 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 3.60%, the default risk premium for Crockett’s bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on Crockett’s bonds is LP = 0.90% versus zero for T bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) × 0.1%, where t = number of years to maturity. What inflation premium (IP) is built into 5-year bond yields?

    a. 0.68%
    b. 0.75%
    c. 0.83%
    d. 0.91%
    e. 1.00%
    b

    Basic equation: r = r* + IP + MRP + DRP + LP
    rCrockett Not needed in this problem 6.35%
    LP Not needed in this problem 0.90%
    DRP Not needed in this problem 1.00%
    rT-bond Required data 4.75%
    r* Required data 3.60%
    Years to maturity Required data 5
    MRP = (t – 1) × (0.1) = 0.40%
    IP = rT-bond ? r* ? MRP 0.75%

    why is it that if i use the 6.35% = 1+3.6+0.4+0.9+IP
    i didnt get the same answer? i got 0.45%

    April 12, 2014 at 6:46 am #165091
    csacct1
    Member
    • Topics: 14
    • Replies: 19
    • ☆

    Another doubt ..

    A 20yr 9% semi annual coupon bond with a par value of $1000 may be called in 8years at a premium of 12%. The bond sells at $1260

    iv) If a friend offers to sell you this bond at $1200, would you take up the offer?

    (( part i it asked the YTM, i found out its 6.63%
    part ii cap/gain loss yield, my answer is 0.51% loss
    part iii YTC, 6.04% ))

    April 12, 2014 at 10:19 am #165103
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    Your first question is not in the F9 syllabus at all.
    I realise that you are doing this for your university exams and not for ACCA, but you should ask your university lecturer about it.

    April 12, 2014 at 10:21 am #165104
    John Moffat
    Keymaster
    • Topics: 57
    • Replies: 54699
    • ☆☆☆☆☆

    Regarding your second question, if there is no other information at all, then the answer is that you would take up the offer. If the bond is trading at $1260 then this is regarded by the market as a fair price, and being able to buy it at $1200 must be worthwhile.
    However, I think there is probably more information in the question than you have typed, and this could well affect things.

    April 12, 2014 at 11:13 am #165112
    csacct1
    Member
    • Topics: 14
    • Replies: 19
    • ☆

    I am sorry sir. We are having study break before finals and couldn’t ask lecturer anymore questions. Anyway,thank you for all your help all this while. You’re great.

  • Author
    Posts
Viewing 5 posts - 1 through 5 (of 5 total)
  • The topic ‘Inflation Premium’ is closed to new replies.

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