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

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.Assume also 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%