3. 3: Interest Rates: Determinants of Market Interest Rate The interest rate on debt, r, is equal to the real risk-free rate plus an inflation premium plus a default risk premium plus a liguidity_premium plus a maturity risk premium. The interest rate on debt, r, is also equal to the risk-free rate plus a default risk premium plus a liquidity premium plus a maturity risk premium. The real risk-free rate of interest may be thought of as the interest rate on U.S. Treasury securities in an inflation-free world. A Treasury Inflation Protected Security (TIPS) is free of most risks, and its value increases with inflation. Short-term TIPS are free of default, maturity, and liquidity risks and of risk due to changes in the general level of interest rates. However, they are not free of changes in the real rate. Our definition of the risk-free rate assumes that, despite the recurities have no meaningful default risk. The inflation premium is equal to the average expected inflation rate over the life of the security. hard time paying off their debts. A liquid asset can be converted to cash quickly at a "fair market value." Real assets are generally liquid than financial assets, but different financial assets vary in their liquidity. Assets with higher trading volume are generally liquid. The average liquidity premium varies over time. Quantitative Problem: expected to be 2.2% next year, 3.2% the following year, 4.2% the third year, and 5.2% every year thereafter. The maturity risk premium is estimated to be 0.11, t ) where t= number of years to maturity. The liquidity premium on relevant 5 -year securities is 0.5% and the default risk premium on relevant 5 year securities is 1%. a. What is the yield on a 1-year T-bill? Round your answer to one decimal place. % b. What is the yield on a 5-year T-bond? Round your answer to one decimal place. % c. What is the yield on a 5-year corporate bond? Round your answer to one decimal place. % 3. 3: Interest Rates: Determinants of Market Interest Rate The interest rate on debt, r, is equal to the real risk-free rate plus an inflation premium plus a default risk premium plus a liguidity_premium plus a maturity risk premium. The interest rate on debt, r, is also equal to the risk-free rate plus a default risk premium plus a liquidity premium plus a maturity risk premium. The real risk-free rate of interest may be thought of as the interest rate on U.S. Treasury securities in an inflation-free world. A Treasury Inflation Protected Security (TIPS) is free of most risks, and its value increases with inflation. Short-term TIPS are free of default, maturity, and liquidity risks and of risk due to changes in the general level of interest rates. However, they are not free of changes in the real rate. Our definition of the risk-free rate assumes that, despite the recurities have no meaningful default risk. The inflation premium is equal to the average expected inflation rate over the life of the security. hard time paying off their debts. A liquid asset can be converted to cash quickly at a "fair market value." Real assets are generally liquid than financial assets, but different financial assets vary in their liquidity. Assets with higher trading volume are generally liquid. The average liquidity premium varies over time. Quantitative Problem: expected to be 2.2% next year, 3.2% the following year, 4.2% the third year, and 5.2% every year thereafter. The maturity risk premium is estimated to be 0.11, t ) where t= number of years to maturity. The liquidity premium on relevant 5 -year securities is 0.5% and the default risk premium on relevant 5 year securities is 1%. a. What is the yield on a 1-year T-bill? Round your answer to one decimal place. % b. What is the yield on a 5-year T-bond? Round your answer to one decimal place. % c. What is the yield on a 5-year corporate bond? Round your answer to one decimal place. %