Problem 5-10

The Habender Company just issued a two-year bond at 12%. Inflation is expected to be 5% next year and 6% the year after. Habender estimates its default risk premium at about 1.5% and its maturity risk premium at about 0.5%. Because it's a relatively small and unknown firm, its liquidity risk premium is about 2.1% even on relatively short debt like this. What pure interest rate is implied by these assumptions? Round your answer to one decimal place.

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