Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 5% per year for each of the next four years and 4% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t - 1)%, where t is the security's maturity. The liquidity premium (LP) on all Smith and Carter Inc.'s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Rating Default Risk Premium Smith and Carter Inc. issues eight-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity. The yield on a AAA-rated bond will be higher than the yield on a BB-rated bond