a) Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 4 percent, and inflation is expected to be 2 percent for the next two years, 3 percent for the following four years, and 4 percent thereafter. The maturity risk premium is estimated by this formula: MRP = 0.1%(t = 1). The liquidity premium for the corporate bond is estimated to be 0.7 percent. Finally, you may determine the default risk premium, given the company's bond rating, from the default risk premium table in the text. What yield would you predict for each of these two investments?

b) Given the following Treasury bond yield information from the September 27, 1999, Wall Street Journal, construct a graph of the yield curve as of that date.

MATURITY______________ YIELD

1 year................................. 5.37%

2 years.................................. 5.47

3 years.................................. 5.65

4 years................................... 5.71

5 years................................... 5.64

10 years................................. 5.75

20 years................................. 6.33

30 years................................. 5.94

c) Based on the information about the corporate bond that was given in part a, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds.

d) Using the Treasury yield information above, calculate the following forward rates:

(1) The 1-year rate, 1 year from now.

(2) The 5-year rate, 5 years from now.

(3) The 10-year rate, 10 years from now.

(4) The 10-year rate, 20 years from now.