7a. Assume that the real risk-free rate is r* = 3.5% and the average expected inflation rate is 2% for the foreseeable future. You are considering buying a bond, Bond X, whose Default Risk |(DRP) and Liquidity Risk (LR) premiums are each 0.4%, and the applicable Maturity Premium (MRP) is 2.5%. What is Bond X's interest rate? 3.5% Inflation Premium Default Risk Premium Liquidity Premium Maturity Risk Premium Bond X interest rate 7b. Answer the following two questions about Bond X in the highlighted boxes: (1) Is Bond X a Treasury bond or a Corporate bond? Why? (1) (2) Is Bond X more likely to have a 3-month or a 20-year maturity? Why (2) 70. Assume the interest rate on a 1-year T-bond is currently 7.5% and the rate on a 2-year bond is 9.1%. If the maturity risk premium is zero, what is a reasonable forecast of the rate on a 1- year bond next year if the Pure Expectations Theory holds? Note: If the theory holds then e.g. (1 + ra)2 = (1 + r1)*(1 + 111) 1-year Treasury yield (ru) 2-year Treasury yield (ra) Maturity Risk Premium 1-year rate, 1 year from now (161) 7d. What would the forecast be if the maturity risk premium on the 2-year bond was 0.5% versus zero for the 1-year bond? 1-year Treasury yield (11) 2-year Treasury yield (r2) Maturity Risk Premium 1-year rate, 1 year from now (101)