# Suppose that you and most other investors expect the inflation rate to be 7% next year, to

## Question:

Suppose that you and most other investors expect the inflation rate to be 7% next year, to fall to 5% during the following year, and then to remain at a rate of 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on government securities rise from zero on very short-term securities (those that mature in a few days) to a level of 0.2 percentage point for 1-year securities. Furthermore, maturity risk premiums increase 0.2 percentage point for each year to maturity, up to a limit of 1.0 percentage point on 5-year or longer-term bonds.

a. Calculate the interest rate on 1-, 2-, 3-, 4-, 5-, 10-, and 20-year Treasury securities, and plot the yield curve.

b. Now suppose Royal Bank bonds, rated A, have the same maturities as the government bonds. As an approximation, plot a Royal Bank yield curve on the same graph with the Government of Canada bond yield curve.

c. Now plot the approximate yield curve of Rogers Communications, a more risky cable company.

Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest...
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