2. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 5%, and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0.01(t - 1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.3%. You may determine the default risk premium (DRP), given the company's bond rating, from the following table. Remember to subtract the bond's LP from the corporate spread given in the table to arrive at the bond's DRP.

   			Corporate Bond Yield
   	Rate		Spread = DRP + LP
   U.S. Treasury	0.83	%
   AAA corporate	1.03		0.20	%
   AA corporate	1.39		0.56
   A corporate	1.81		0.98

   What yield would you predict for each of these two investments? Round your answers to three decimal places.

   12-year Treasury yield: fill in the blank 7 %

   7-year Corporate yield: fill in the blank 8 %

Based on the information about the corporate bond provided in part b, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds. Round your answers to two decimal places.

Years		Treasury yield		A-corporate yield
1		5.42	%	fill in the blank 10 %
2		5.52	%	fill in the blank 11 %
3		5.75	%	fill in the blank 12 %
4		5.81	%	fill in the blank 13 %
5		5.73	%	fill in the blank 14 %
10		5.86	%	fill in the blank 15 %
20		6.34	%	fill in the blank 16 %
30		6.05	%	fill in the blank 17 %

1. Which part of the yield curve (the left side or right side) is likely to be most volatile over time?

   Short-term rates are

   moreless

   volatile than longer-term rates; therefore, the

   leftright

   side of the yield curve would be most volatile over time.

2. Using the Treasury yield information in part c, calculate the following rates using geometric averages (round your answers to three decimal places):

   1. The 1-year rate, 1 year from now

      fill in the blank 21 %

   2. The 5-year rate, 5 years from now

      fill in the blank 22 %

   3. The 10-year rate, 10 years from now

      fill in the blank 23 %

   4. The 10-year rate, 20 years from now

      fill in the blank 24