16053 Homework 3. Assume that the real risk-free rate of retum, cis 2 percent, and it will remain at that level far into the future. Also assume that the maturity risk premiums on Treasury bonds increase from zero for bonds that mature in one year or less to a maximum of 1.2 percent, and MRP increases by 0.1 percent for each year to maturity that is greater than one year - that is, MRP equal to 0.1 percent for a two-year band, 0.2 percent for a three-year bond, and so forth. The expected inflation rates are listed in the table below. Average Expected Inflation Interest Rate on Bonds MRP Year 1 2 3 4 5 Inflation Rate 5.0% 4.0% 3.5% 2.5% 2.2% a) What is the average expected inflation rate for a one-, two, three-, four, and five-year bond? Calculate and show your answer in the table above. b) What should be the MRP for a one-, two, three-, four, and five-year bond? Calculate and show your answer in the table above. c) d) Compute the interest rate one, two, three-, four-, and five-year bond? Calculate and show your answer in the table above. e) If inflation is expected to equal 2 percent every year after Year 5, what should be the interest rate for a 10- and 15-year bond? 16053 Homework 3. Assume that the real risk-free rate of retum, cis 2 percent, and it will remain at that level far into the future. Also assume that the maturity risk premiums on Treasury bonds increase from zero for bonds that mature in one year or less to a maximum of 1.2 percent, and MRP increases by 0.1 percent for each year to maturity that is greater than one year - that is, MRP equal to 0.1 percent for a two-year band, 0.2 percent for a three-year bond, and so forth. The expected inflation rates are listed in the table below. Average Expected Inflation Interest Rate on Bonds MRP Year 1 2 3 4 5 Inflation Rate 5.0% 4.0% 3.5% 2.5% 2.2% a) What is the average expected inflation rate for a one-, two, three-, four, and five-year bond? Calculate and show your answer in the table above. b) What should be the MRP for a one-, two, three-, four, and five-year bond? Calculate and show your answer in the table above. c) d) Compute the interest rate one, two, three-, four-, and five-year bond? Calculate and show your answer in the table above. e) If inflation is expected to equal 2 percent every year after Year 5, what should be the interest rate for a 10- and 15-year bond