How much higher would the rate of return be on

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Reference no: EM132015877

Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the number of years to maturity.

Suppose also that a liquidity premium of 0.50% and a default risk premium of 2.50% apply to A-rated corporate bonds but not to T-bonds.

How much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5-year Treasury bond?

Here we assume that the pure expectations theory is NOT valid. Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Reference no: EM132015877

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