The real risk-free rate (r*) is 2.80% and is expected to remain constant into the future. Inflation is expected to be 5.10% per year for each of the next two years and 3.90% thereafter.

The maturity risk premium (MRP) is determined from the formula: 0.10 x (t 1)%, where t is the securitys maturity. The liquidity premium (LP) on all Harrington Horticulture Co.s bonds is 0.60%. 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% Harrington Horticulture Co. issues fourteen-year, AA-rated bonds. What is the yield on one of these bonds? (Hint: Disregard cross-product terms; that is, if averaging is required, use an arithmetic average.) 8.97% 9.57% 8.27% 5.50% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? A AAA-rated bond has less default risk than a BB-rated bond. A BBB-rated bond has a lower default risk premium as compared to a AAA-rated bond