Suppose the inflation rate is expected to be 2% next year, 2% the following year, 2.5% in year 3, and 3% thereafter. Assume that the risk-free rate r*, will remain at 1% and that maturity risk premium on Treasury securities increases .2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds. Calculate the interest rate difference between a 5-year and 10-year Treasury bond.

.4

.75

.25

.9

.5