7. Calculating interest rates The real risk-free rate (r*) is 2.80% and is expected to remain constant into the future. Inflation is expected to be 3.20% per year for each of the next two years and 2.00% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.10 x (t-1)%, where t is the security's maturity. The liquidity premium (LP) on all Berth Construction Inc.'s bonds is 0.60%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium U.S. Treasury AAA AA 0.60% 0.80% 1.05% A BBB 1.45% Berth Construction Inc. issues eight-year, AA-rated bonds. What is the yield on one of these bonds? (Hint: Disregard cross-product terms; that is, if averaging is required, use an arithmetic average.) 4.90% 7.20% 6.50% 6.60% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on a AAA-rated bond will be lower than the yield on a AA-rated bond. A BBB-rated bond has a lower default risk premium as compared to a AAA-rated bond