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Q13. The real risk-free rate is 2% and will remain constant for the next 5 years. Inflation is expected to be 2.5% next year; 3.0

Q13. The real risk-free rate is 2% and will remain constant for the next 5 years. Inflation is expected to be 2.5% next year; 3.0 % the following year, and 5% thereafter. The maturity risk premium is estimated to be 0.1(t-1) %, where t is the number of years to maturity. The liquidity premium for a 1-year corporate bond and a 5-year corporate bond is 0.6%. The default risk premium for a 1-year corporate bond and a 5-year corporate bond is estimated to be 0.50%. Instructions: a. What is the yield on a 1-year Treasury bond and 1-year Corporate bond? b. What is the yield on a 5-year Treasury bond and 5-year Corporate bond? c. Now, suppose that the yield on a 2-year Treasury security is 5.0%, and the yield on a 5-year Treasury security is 5.20%. Assuming that the pure expectation theory is correct, what is the markets estimate of the 3-year Treasury security rate two years from now?

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