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8. [8 Points] Assume the real risk free rate is 3%, and inflation is expected to be 4% in Year 1, 7% in Year 2,

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8. [8 Points] Assume the real risk free rate is 3%, and inflation is expected to be 4% in Year 1, 7% in Year 2, and 2% thereafter forever. Assume alsofthat all Treasury securities are highly liquid and free of default risk. Suppose 5-year Treasury bonds yield 12% (a) What is the maturity risk premium associated with the 5-year Treasury bonds? (b) Now consider otherwise equivalent 5-year TIPS (Treasury Inflation Protected Se- curities). What is their yield to maturity? 5

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