Suppose the Real Risk-Free Rate Is 3

question 9

Multiple Choice

Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.50%, a maturity premium of 0.02% per year to maturity applies, i.e., MRP = 0.20%(t) , where t is the years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 1.35% applies to A-rated corporate bonds. What is the difference in the yields on a 5-year A-rated corporate bond and on a 10-year Treasury bond? Here we assume that the pure expectations theory is NOT valid, and disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

• A) 0.77%
• B) 0.81%
• C) 0.85%
• D) 0.89%
• E) 0.94%

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Definitions:

United States

A country in North America consisting of 50 states and a federal district, known for its significant cultural and economic influence globally.

Boas

Franz Boas was an anthropologist who is considered one of the founders of cultural anthropology and an advocate of cultural relativism.

Pavlov

A Russian physiologist known for his work in classical conditioning, demonstrating how organisms can learn to associate a neutral stimulus with a reflexive response.

Wundt

Refers to Wilhelm Wundt, a German physician, physiologist, and philosopher, widely regarded as the father of experimental psychology.