Plot the approximate yield curve of a much riskier lower

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Suppose the inflation rate is expected to be 7% next year, 5% the following year, and 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds(those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer termT-bonds.

Suppose a AAA-rated company(which is the highest bond rating a firm can have)had bonds with the same maturities as the Treasury bonds. Estimate and plot what you belive a AAA-rated company's yield curve would look like on the same graph with the Treasury bond yield curve and on the same graph, plot the approximate yield curve of a much riskier lower-rated company with a much higher risk of defaulting on its bonds.

Reference no: EM13287725

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