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1. Due to a recession, expected inflation this year is only 4.25%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 4.25%. Assume that the expectations theory holds and the real risk-free rate (r*) is 3.5%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 1.5%, what inflation rate is expected after Year 1? Round your answer to two decimal places. 2. A company's 5-year bonds are yielding 8% per year. Treasury bonds with the same maturity are yielding 4.1% per year, and the real risk-free rate (r*) is 2.45%. The average inflation premium is 1.25%, and the maturity risk premium is estimated to be 0.1 × (t - 1)%, where t = number of years to maturity. If the liquidity premium is 1%, what is the default risk premium on the corporate bonds? Round your answer to two decimal places. 3. An investor in Treasury securities expects inflation to be 1.6% in Year 1, 2.0% in Year 2, and 3.15% each year thereafter. Assume that the real risk-free rate is 2.35% and that this rate will remain constant. Three-year Treasury securities yield 6.70%, while 5-year Treasury securities yield 8.00%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 - MRP3? Do not round intermediate calculations. Round your answer to two decimal places. 4. The real risk-free rate, r*, is 1.6%. Inflation is expected to average 1.3% a year for the next 4 years, after which time inflation is expected to average 4.5% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 11.6%, which includes a liquidity premium of 0.4%. What is its default risk premium? Do not round intermediate calculations. Round your answer to two decimal places. 5. A 5-year Treasury bond has a 5.4% yield. A 10-year Treasury bond yields 6.2%, and a 10-year corporate bond yields 9.0%. The market expects that inflation will average 2.0% over the next 10 years (IP10 = 2.0%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described. What is the yield on this 5-year corporate bond? Round your answer to one decimal place.
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