1. Use the supply and demand for bonds model to analyze the effect of an increase in default risk on corporate bonds. What is the effect on the price of corporate bonds and the interest rate? Please attach a graph showing your work. (8 points) Hint: In the corporate bond market, start with the supply and demand model for corporate bonds. Decide which curve will shift due to the increase in default risk in corporate bonds and to what direction. Check what happens to the price of corporate bonds and the interest rate at the new equilibrium.

2. If the estimated return on a corporate bond is 8%, while the return on US Treasury bond is 3%. How much is the risk premium in this case? (2 points) Hint: The risk premium is the compensation investors required to hold the risky asset. It equals the expected return on the risky investment minus the risk-free return.