The Cost of Money $($Interest Rates$)$

a$.$ Assume the expected inflation rates for the next five years are as follows:

In Year $6$ and thereafter, inflation is expected to be $3$ percent. The maturity risk premium $($MRP$)$ is

$0\mathrm{.}1$ percent per year to maturity for bonds with maturities greater than six months, with a maximum

MRP equal to $2$ percent. The real risk$-$free rate of return is currently $2\mathrm{.}5$ percent, and it is expected to

remain at this level long into the future. Compute the interest rates on Treasury securities with

maturities equal to one year, two years, three years, four years, five years, $10$ years, $20$ years, and $30$

years. Draw the yield curve.

b$.$ Discuss the yield curve that is constructed from the results in part $($a$).$ Describe what the shape of the

yield curve indicates about future interest rates.