Suppose the Real Risk-Free Rate Is 3

Multiple Choice

Suppose the real risk-free rate is 3.50%,the average future inflation rate is 2.50%,a maturity premium of 0.20% per year to maturity applies,i.e.,MRP = 0.20%(t) ,where t is the number of 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%