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

Multiple Choice

Assume that the real risk-free rate is 4 percent, and that inflation is expected to be 9 percent in Year 1, 6 percent in Year 2, and 4 percent 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 percent, what is the difference in the maturity risk premiums (MRPs) on the two bonds, i.e., what is MRP5 - MRP2? (Round answer to one decimal place.)

A) 2.1%
B) 1.8%
C) 0.5%
D) 3.1%
E) 2.6%