The real risk-free rate, r*, is 1.20%, and inflation is expected to be 2.00% this year, 3.00% for the next three years, and 4.25% per year thereafter. The maturity risk premium is estimated to be 0.07%(t-1), where t = number of years to maturity. Liquidity risk premium is 0.75%, default risk premium is 1.25%.

Questions Answers 1. What is the interest rate for 1-year Treasury bill (T-bill)?

2. What is the interest rate for 4-year Treasury bond?

3. What is the interest rate for 7-year Treasury bond? Answer %

4. What is the interest rate for 1-year Corporate bond? Answer %

5. What is the interest rate for 4-year Corporate bond? Answer %

6. What is the interest rate for 7-year Corporate bond? Answer %

7. Assume we believe PEH holds true (MRP = 0), what should be the yield of 6-year Treasury bond one year from now? Answer %

8. From your calculation in question 1-6. If you draw yield curves of Treasury-Bond and Corporate bond, which one should stay below?

9. Without calculation, if you draw yield curves of two corporate bonds, one with BBB and another one with AA+, which yield curve should stay above?

10. From question 9, what factor causes the difference in credit rating of these two corporate bonds (BBB and AA+)?