4-7: The Pre-Tax Cost of Debt: Determinants of Market Interest Rates Problem 4-23 Determinants of Interest Rates Suppose you and most other investors expect the inflation rate to be 6% next year, to fall to 4% during the following year, and then to remain at a rate of 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term securities (those that mature in a few days) to a level of 0.2 percentage points for 1-year securities. Furthermore, maturity risk premiums increase 0.2 percentage points for each year to maturity, up to a limit of 1.0 percentage point on 5-year or longer-term T-notes and T-bonds. a. Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places. % Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places. %% Rates B 191 18+ b. Select the correct graph for approximate yield curve of Long Island Lighting Company, a risky nuclear utility & yield curve based on the results above in Requirement a. Now suppose ExxonMobil's bonds, rated AAA, have the same maturities as the Treasury bonds. As an approximation, plot an ExxonMobil yield curve on the same graph with the Treasury bond yield curve. (Hint: Think about the default risk premium on ExxonMobil's long-term versus its short-term bonds.) Select the correct graph. A 19 Interest Rate I Interest Rate 18+ 17 17 16+ 15 14+ 13 Treasury LILCO 121 11 10+ Excxon 101 Exxon 9 91 8+ 8+ LILCO 7 Treasury Years to Maturity Years to Maturity 7+ 2 4 6 8 10121416182022 24 -4-251 2 4 6 8 10121416182022 24 16+ 15 ODNOM NOO 14 13 121 11; DO -4-25 D 19 Interest Rate 18 17 16 15 14 13 Exxon 12 11 10 LILCO 9+ 19 Interest Rate 18+ 17+ 16 15 141 13 LILCO 12 11 101 9 8+ Treasury + + 5 45 1 D 10 Interest Rate Interest Rate 194 18+ 17 16+ 15 14 13 Boxon 12 11 10 LILCO 9 8 Treasury 71 18+ 17+ 16+ 15+ 14+ 13 12 11 10+ 9+ 8+ 7 LILCO Treasury Years to Maturity Eexon Years to Maturity -4-25 2 4 6 8 10121416182022 24 -4 -25 2 4 6 8 10121416182022 24 The correct graph is -Select- : Check My Work (1 remaining) 0 Icon Key