Suppose the real risk-free rate is 2.5%, the average future inflation rate is

4.8%, a maturity premium of 0.06% per year to maturity applies, i.e., MRP =

0.06%(t), where t is the years to maturity. Suppose also that a liquidity premium

of 0.9% and a default risk premium of 0.7% applies to A-rated corporate bonds.

How much higher would the rate of return be on a 7-year A-rated corporate

bond than on a 5-year Treasury bond. Here we assume that the pure

expectations theory is NOT valid.

1.72%

1.92%

1.52%

1.32%

1.12%