Inflation

Due to a recession, expected inflation this year is only 2.75%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 2.75%. Assume that expectations theory holds and the real risk-free rate is r* = 2.25%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 2.25%, what inflation rate is expected after Year 1? Round your answer to two decimal places.

Default Risk Premium

The real risk-free rate, r*, is 3.1%. Inflation is expected to average 2.75% a year for the next 4 years, after which time inflation is expected to average 4.65% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 10.4%, which includes a liquidity premium of 0.9%. What is its default risk premium? Round your answer to two decimal places.

Interest Rate Premiums

A 5-year Treasury bond has a 3.7% yield. A 10-year Treasury bond yields 6.8%, and a 10-year corporate bond yields 8.2%. The market expects that inflation will average 1.5% over the next 10 years (IP₁₀ = 1.5%). Assume that there is no maturity risk premium (MRP = 0), and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0). A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described above. What is the yield on this 5-year corporate bond? Round your answer to two decimal places.