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Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity
Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP =0.07%(t), where t is the number of years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 1.20% apply to A. rated corporate bonds but not to T-bonds. How much higher would the rate of retum be on a 10-year A-rated comporate bond than on a S-year Treasury bond? Here we assume that the pure expectations theory is NOT valid. Distegard eross-product terms, i.e., if averaging is required, use the arithmetic average: 1.89% 2.07% 2.05% 1.72% 2.28%
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