Assume That Real Risk-Free Rate (R*) = 1

question 40

Multiple Choice

Assume that real risk-free rate (r*) = 1.0%; the maturity risk premium is found as MRP = 0.2% × (t - 1) where t = years to maturity; the default risk premium for AT&T bonds is found as DRP = 0.07% × (t - 1) ; the liquidity premium is 0.50% for AT&T bonds but zero for Treasury bonds; and inflation is expected to be 7%, 6%, and 5% during the next three years and then 4% thereafter. What is the difference in interest rates between 10-year AT&T bonds and 10-year Treasury bonds?

• A) 0.25%
• B) 0.50%
• C) 0.63%
• D) 1.00%
• E) 1.13%

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Definitions:

Corridor Threshold

A term used in pension accounting that refers to the allowable range in fluctuation in the value of pension assets or liabilities; amounts outside this corridor may require amortization to keep the pension's accounting measures stable.

Pension Expense

The annual cost recognized by an employer for its contributions to employees' retirement plans, reflecting the cost of benefits earned by employees during the year.

Pension Funding

The process of allocating financial resources to a pension plan to meet future obligations to retirees.

Upcoming Year

Refers to the next calendar or fiscal year that is approaching and for which plans, budgets, or forecasts are being prepared.