(Example 5-4) The interest rate outlook for Monsato Corporation., a large, financially sound company, is reflected in the following information:

(1) The pure rate of interest is 1%.

(2) Inflation is expected to increase in the future from its current low level of 1%. Predicted annual inflation rates follow:

Year Inflation Rate

1 1%

2 2%

3 3%

4 4%

5-20 5%

(3) The default risk premium will be .1% for one-year debt, but will increase .1% for each additional year of term to a maximum of 1%.

(4) The liquidity premium is zero for one and two-year debt, .5% for three-, four-, and five-year terms and 1% for longer issues.

(5) The maturity risk premium is zero for a one-year term and increases by .2% for each additional year of term to a maximum of 2%.

Use the interest rate model to estimate market rates on the firm's debt securities of the following terms: 1 to 5 years, 10 years, and 20 years.

Year	Inflation Rate		Inflation adjustment
1
2
3
4
5
10
20

Term	kPR +	INFL +	DR +	LR+	MR=	k
1
2
3
4
5
10
20