Question
The Brookings Institute estimates the real risk free rate as r * = 1.0%; the maturity risk premium uses this function for all bonds in
The Brookings Institute estimates the real risk free rate as r* = 1.0%; the maturity risk premium uses this function for all bonds in the economy: MRP = 0.2%(t 1) where t = years to maturity; the default risk premium for WorkNow bonds is found as DRP = 0.07%(t 1); the liquidity premium is 0.50% for WorkNow bonds but zero for Treasury notes; and inflation is expected to be 7%, 6%, and 5% during the next three years and then 4% thereafter. What is the difference in interest rates between 10-year WorkNow bonds and 10-year Treasury notes (T-notes are assumed to be default free)?
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