$6-17$

INTEREST RATE PREMIUMS A $5-$year Treasury bond has a $5\mathrm{.}2\%$ yield. A $10-$year Treasury bond yields $6\mathrm{.}4\%,$ and a $10-$year corporate bond yields $8\mathrm{.}4\%.$ The market expects that inflation will average $2\mathrm{.}5\%$ over the next $10$ years

$($

IP

$10$

$=$

$2\mathrm{.}5$

$\%$

$)$

$.$ Assume that there is no maturity risk premium

$($

MRP

$=$

$0$

$)$

and that the annual real risk$-$free rate,

r

$*$

$,$ will remain constant over the next $10$ years. $($Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities:

DRP

$=$

LP

$=$

$0$

$.)$ A $5-$year corporate bond has the same default risk premium and liquidity premium as the $10-$year corporate bond described. What is the yield on this $5-$year corporate bond?