integrated mini$-$case Calculating Interest Rates

From discussions with your broker, you have determined that the expected inflation

premium is $1\mathrm{.}35$ percent next year, $1\mathrm{.}50$ percent in year $2,1\mathrm{.}75$ percent in year $3,$ and

$2\mathrm{.}00$ percent in year $4$ and beyond. Further, you expect that real risk$-$free rates will be

$3\mathrm{.}20$ percent next year, $3\mathrm{.}30$ percent in year $2,3\mathrm{.}75$ percent in year $3,$ and $3\mathrm{.}80$ percent

in year $4$ and beyond. You are considering an investment in either five$-$year Treasury

securities or five$-$year bonds issued by PeeWee Corporation. The bonds have no special

covenants. Your broker has determined the following information about economic

activity and PeeWee Corporation five$-$year bonds:

Default risk premium $=2\mathrm{.}10\%$

Liquidity risk premium $=1\mathrm{.}75$

Maturity risk premium $=0\mathrm{.}75$

Further, the maturity risk premium on PeeWee bonds is $0\mathrm{.}1875$ percent per year starting

in year $2.$ PeeWee's default risk premium and liquidity risk premium do not change with

bond maturity.

a$.$ What is the fair interest rate on five$-$year Treasury securities$?$

b$.$ What is the fair interest rate on PeeWee Corporation five$-$year bonds?

c$.$ Plot the five$-$year yield curve for the Treasury securities$.$

d$.$ Plot the five$-$year yield curve for the PeeWee Corporation bonds.