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Assume that the real risk-free rate of return, k*, is 3%, and it'll stay at that level far into the future. Also count on that
Assume that the real risk-free rate of return, k*, is 3%, and it'll stay at that level far into the future. Also count on that maturity risk premiums (MRP) boom from zero for bonds that mature in one year or less to a maximum of 1%, and MRP will increase by 0.2% for every year to maturity that is more than one year that is, MRP equals 0.2% for two-year bond, 0.4% for a three-year bond, and so forth. Following are the anticipated inflation rates for the following 5 years: Inflation Rate (%) 3 4 Year 2017 2018 2019 2020 2021 5 6 7 1. Compute the interest rate for a one-, two-, three-four-, and five-year bond. (5 marks) II. if inflation rate is expected to be equal 7% every year after 2021, what should be the interest rate for a 10- and 20-year bond? (2 marks) III. Plot the yield curve for the interest rates you computed in part (a) and [b]. (1 mark) IV. Based on the curve (in ili) what would you do if you are the lender? Are going to lend more? Or less? Explain your answer. (2 marks)
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