Assume That the Real Risk-Free Rate, R*, Is 4 Percent

question 15

Multiple Choice

Assume that the real risk-free rate, r*, is 4 percent, and that inflation is expected to be 9% in Year 1, 6% in Year 2, and 4% thereafter. Also, assume that all Treasury bonds are highly liquid and free of default risk. If 2-year and 5-year Treasury bonds both yield 12%, what is the difference in the maturity risk premiums (MRPs) on the two bonds, i.e., what is MRP5 - MRP2?

• A) 2.1%
• B) 1.8%
• C) 5.0%
• D) 3.0%
• E) 2.5%

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Definitions:

Louis XIV

A monarch of the House of Bourbon who reigned as King of France from 1643 until his death in 1715, known for his absolute monarchy and the phrase "L'état, c'est moi."

Tribal Societies

Groups of people organized around kinship or other forms of obligation and identified by cultural and social unity, often living in traditional, pre-industrial societies.

Feudal Societies

Societies structured around a strict hierarchical system of lords, vassals, and serfs, prevalent in medieval Europe, where lands were held in exchange for service.

Traditional Authority

A form of leadership where power is legitimized by customs and traditional beliefs passed down through generations, often seen in monarchies or tribes.