138 PA R T I I Financial Markets *8 What are the financial implications of a firm with a high default risk? Predicting the Future Predict what will happen to interest rates on a corporation s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future What will happen to the interest rates on Canada bonds? 11 Predict what would happen to yield spreads in response to the following macroeconomic events: recession, high inflation, and stock market increase *12 If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future? 13 If expectations of future short-term interest rates suddenly fall, what would happen to the slope of the yield curve? *10 Predict what would happen to the risk premiums on corporate bonds if brokerage commissions were lowered in the corporate bond market Q U A N T I TAT I V E P R O B L E M S *1 Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves for the following series of one-year interest rates over the next five years: (a) 5%, 7%, 7%, 7%, 7% (b) 5%, 4%, 4%, 4%, 4% How would your yield curves change if people preferred shorter-term bonds to longer-term bonds? Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves for the following path of one-year interest rates over the next five years: (a) 5%, 6%, 7%, 6%, 5% (b) 5%, 4%, 3%, 4%, 5% How would your yield curves change if people preferred shorter-term bonds to longer-term bonds? *3 Rates on one-year T-bills over the next four years are expected to be 3%, 4%, 5%, and 5.5% If fouryear Canada bonds are yielding 4.5%, what is the liquidity premium on this bond? Suppose that you are forecasting one-year T-bill rates as follows: Year 1-year rate (%) 4.25 5.15 5.50 6.25 7.10 You have a liquidity premium of 0.25% for the next year and 0.50% thereafter Would you be willing to purchase a four-year Canada bond at a 5.75% interest rate? CANSIM Questions Get the monthly data from 1978 to 2006 on the three-month T-bill rate (CANSIM series V122531), the interest rate on long-term corporate bonds (series V122518), and the interest rate on long-term Canada bonds (series V122544) from the Textbook Resources area of the MyEconLab a Present a time series plot of these interest rate series and comment on their long-run movements b Calculate the mean and standard deviation as well as the maximum and minimum values for each series over the sample period c Which were the worst and best years in terms of interest rates? Get the monthly data from 1978 to 2006 on longterm Canada bonds (CANSIM series V122544), the interest rate on long-term provincial bonds (series V122517), and the interest rate on long-term corporate bonds (series V122518) from the Textbook Resources area of the MyEconLab a Present a time series plot of these interest rates and comment on their long-term movements b Which series exhibit the strongest correlations? The weakest? Do the correlation patterns you identified here manifest in the graphical representation of the series? c Compare the contemporaneous correlations over the whole period with those in the 1960s, 1970s, 1980s, 1990s, and 2000s d Calculate the corporate-Canada spread and the corporate-provincials spread and plot these series e Continuing from (d), comment on the time paths of the risk premiums