INFLATION AND INTEREST RATES The real risk-free rate of interest, r*, 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 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?

AppendixLO1