The real risk-free rate of interest, is 3%, and it is expected to remain constant over time. Inflation is expected to be 2% per year for the next 3 years and 4% per year for the next 5 years. The maturity risk premium is equal to 0.1 x (t-1) %, where t = the bond's maturity. The default risk premium for a BBB-rated bond is 1.3%.

A What is the average expected inflation rate over the next 4 years?

B What is the yield on a 4-year Treasury bond?

C What is the yield on a 4-year BBB-rated corporate bond with a liquidity premium of 0.5%?

D What is the yield on an 8-year Treasury bond?

E What is the yield on an 8-year BBB-rated corporate bond with a liquidity premium of 0.5%?

F If the yield on a 9-year Treasury bond is 7.3%, what does that imply about expected inflation in 9 years?

Answer rating: 100% (QA)

Solution A The average expected inflation rate over the next 4 years can be calculated as follows Average inflation rate inflation rate for year 1 inflation rate for year 2 inflation rate for year 3 i... View the full answer