Suppose you are considering two possible investment opportunities: the first is a 10 year Treasury Bond and the second, is a 7 year A-rate corporate bond. The current real risk free rate is 4% 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 the following formula: MRP= .02(t-1). The liquidity premium for the corporate bond is estimated to be .30%. The default risk premium can be determined from the table below.

Determine the default risk premium (DRP) given the company's bond rating, from the table below. Remember to subtract the bonds LP from the corporate spread given in the table to arrive at the bonds DRP. What yield would you predict for each of these two investments?

Bond Type	Rate	Corporate Bond Yield Spread = (DRP+LP)
U.S Treasury	.83	0%
AAA Corporate	.93	.10%
AA Corporate	1.29	.46%
A Corporate	1.67	.84%

Maturity	Yield
1 year	5.37%
2 years	5.47
3 years	5.67
4 years	5.71
5 years	5.64
10 years	5.75
20 years	6.33
30 years	5.94

D. Based on the information about the corporate bonds in part b, calculate yields and then construct a new yield curve graph that shows both the treasury and the corporate bonds.

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

F. Using the Treasury yield information in part c, calculate the following rates using geometric averages:

1. The 1-year rate 1 year from now

2. The 5-year rate 5 years from now

3. The 10-year rate 10 years from now

4. the 10-year rate 20 years from now