ch 06 1. inflation and interest rates /9

For example, if you know that the real rate of interest is 4% and it is expected to remain constant for the next 3 years, inflation is expected to be 1.60% next year, 3.80% the following year, and 4.90% the third year, then the average expected inflation rate over the next three years is 31.0513805+60%=3.43%. If also you can estimate that the maturity risk premium is 0.1(t1)%, where t is number of years to maturity, then the yield on a 1-year Treasury bill, which has neither default risk premiunt nor liquidity risk premium, is as follows: rTI=r+IP1+MRP1=4%+1.60%+0.1(11)%=5.60% Complete the following table by calculating yiolds on a 2. and 3-year Treasury bills, respectively. Unlike Treasury securities, corporate bonds have both a default risk premium and a liquidity risk premium. Suppose that the liquidity premium on 3-year bonds is LP=0.35%, and the default risk premium on 3 -year bonds is DRP=1.40%. The formula for calculating the vield on a corporate bond is roop=r+IP+LP+MRProw=r+IP+DRP+LP+MRProop=IP+DRP+LP+MRProrp=IP+LP+MRP The vield on a 3-year corporate bond is