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, 3.90% the following year, and 5.40% the third year, then the average expected inflation rate over the next three years is 1.60%+3.90%+5.40%3=3.63%1.60%+3.90%+5.40%3=3.63%. If also you can estimate that the maturity risk premium is 0.1(t1)%0.1t1%, where tt is number of years to maturity, then the yield on a 1-year Treasury bill, which has neither default risk premium nor liquidity risk premium, is as follows:

rT1rT1	= =	r*+IP1+MRP1r*+IP1+MRP1
	= =	4%+1.60%+0.1(11)%4%+1.60%+0.111%
	= =	5.60%5.60%

Complete the following table by calculating yields on a 2- and 3year Treasury bills, respectively.

	Yield
2-year Treasury bill
3-year Treasury bill

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%LP=0.35%, and the default risk premium on 3-year bonds is DRP=1.50%DRP=1.50%.

The formula for calculating the yield on a corporate bond is

rcorp=IP+DRP+LP+MRPrcorp=IP+DRP+LP+MRP

rcorp=IP+LP+MRPrcorp=IP+LP+MRP

rcorp=r*+IP+LP+MRPrcorp=r*+IP+LP+MRP

rcorp=r*+IP+DRP+LP+MRPrcorp=r*+IP+DRP+LP+MRP

The yield on a 3year corporate bond is .