Suppose economists have determined that the real risk-free rate of return is 3 percent and that inflation is expected to average 2.5 percent per year long into the future.
A one-year Treasury note offers a rate of return equal to 5.6 percent. You are evaluating two corporate bonds: (1) Bond A has a rate of return, rA, equal to 8 percent; and (2) Bond B has a rate of return, rB, equal to 7.5 percent. Except for their maturities, these bonds are identical—Bond A matures in 10 years, whereas Bond B matures in five years. You have determined that both bonds are very liquid, thus neither bond has a liquidity premium. Assuming that there is an MRP for bonds with maturities equal to one year or greater, compute the annual MRP. What is the DRP associated with corporate bonds?