Assume that the real risk-free rate of return, r*, is 3 percent, and it will remain 'at that level far into the future. Also assume that maturity risk premiums on Treasury bonds increase from zero for bonds that mature in one year or less to a maximum of 2 percent, and MRP increases by 0.2 percent for each year to maturity, that is greater than one year-that is, MRP equals 0.2 percent for a two-year bond, 0.4 percent for a three-year bond, and so forth. Following are the expected inflation rates for the next five years:

Year Inflation Rate

2009 3.0%

2010 5.0

2011 4.0

2012 8.0

2013 3.0

A. what is the average expected inflation rate for a one- , two-, three-, four- and five- year bond?

B. what should be the MRP for a one, two, three, four and five year bond?

C. compute the interest rate for a one, two, three, four and five year bond?

D. if inflation is expected to equal 2 percent every year after 2013, what should the interest rate be for a 10- and 20-year bond?

E. Plot the yield curve for the interest rates you computed in parts c and d.