Principles of Managerial Finance

a. Draw the yield curve associated with these data.

b. Describe the resulting yield curve in part a,and explain the general expecta-

tions embodied in it.

6–5 Nominal interest rates and yield curves A recent study of inflationary expecta-

tions has revealed that the consensus among economic forecasters yields the fol-

lowing average annual rates of inflation expected over the periods noted. (Note:

Assume that the risk that future interest rate movements will affect longer matu-

rities more than shorter maturities is zero; that is, there is no maturity risk.)

a. If the real rate of interest is currently 2.5%, find the nominal interest rate

on each of the following U.S. Treasury issues: 20-year bond, 3-month bill,

2-year note, and 5-year bond.

b. If the real rate of interest suddenly dropped to 2% without any change in

inflationary expectations, what effect, if any, would this have on your

answers in part a?Explain.

c. Using your findings in part a,draw a yield curve for U.S. Treasury securities.

Describe the general shape and expectations reflected by the curve.

d. What would a follower of theliquidity preference theorysay about how the

preferences of lenders and borrowers tend to affect the shape of the yield curve

drawn in partc?Illustrate that effect by placing on your graph a dotted line

that approximates the yield curve without the effect of liquidity preference.

e. What would a follower of the market segmentation theorysay about the sup-

ply and demand for long-term loans versus the supply and demand for short-

term loans given the yield curve constructed for part cof this problem?

6–6 Nominal and real rates and yield curves A firm wishing to evaluate interest

rate behavior has gathered data on nominal rate of interest and on inflationary

expectation for five U.S. Treasury securities, each having a different maturity

and each measured at a different point in time during the year just ended. (Note:

Assume that the risk that future interest rate movements will affect longer matu-

rities more than shorter maturities is zero; that is, there is no maturity risk.)

These data are summarized in the following table.

U.S. Treasury Nominal rate Inflationary

security Point in time Maturity of interest expectation

A Jan. 7 2 years 12.6% 9.5%

B Mar. 12 10 years 11.2 8.2

C May 30 6 months 13.0 10.0

D Aug. 15 20 years 11.0 8.1

E Dec. 30 5 years 11.4 8.3

Period Average annual rate of inflation

3 months 5%

2 years 6

5 years 8

10 years 8.5

20 years 9

CHAPTER 6 Interest Rates and Bond Valuation 297

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