The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 6% per year for each of the next three years and 5% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t 1)%, where t is the securitys maturity. The liquidity premium (LP) on all Global Satellite Corp.s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):

Rating	Default Risk Premium
U.S Treasury	------
AAA	0.60%
AA	0.80%
A	1.05%
BBB	1.45%

Global Satellite Corp. issues fifteen-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average.

- 10.20%

- 6.05%

- 9.85%

- 11.25%

Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?

- Higher inflation expectations increase the nominal interest rate demanded by investors.

- The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond.