Suppose the real risk-free rate is 2.9%, the average future inflation rate is 1.2%, a maturity premium of 0.07% per year to maturity applies, i.e., MRP = 0.07%(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.

1.74%

1.54%

1.34%

1.94%

2.14%