Question: A 5-year Treasury bond has a 4.35% yield. A 10-year Treasury bond yields 6.65%, and a 10-year corporate bond yields 8.65%. The market expects that

A 5-year Treasury bond has a 4.35% yield. A 10-year Treasury bond yields 6.65%, and a 10-year corporate bond yields 8.65%. The market expects that inflation will average 2.7% over the next 10 years (IP10 = 2.7%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described.

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