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Interest rate premiums A 5-year Treasury bond has a 5.2 percent yield. A 10-year Treasury bond yields 6.4 percent, and a 10-year corporate bond yields 8.4 percent. The market expects that inflation will average 2.5 percent over the next 10 years (IP10 _ 2.5%).
Assume that there is no maturity risk premium (MRP _ 0), and that the annual real riskfree rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP _ LP _ 0.)
A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described above. What is the yield on this 5-year corporate bond?

  • Finance -

    Does this sound right to my question?

    10 year at 8.4% with an inflation of 2.5 over that same time period.

    risk free stays the same LP is zero so those are really irrelavant.

    so we need to figure out a five year equation of the above but with five years

    8.4% shouldn't change due to its pretty much locked in
    now the 2.5% predicted inflation is over ten years.
    So that 2.5 needs to be broke down over a ten year span which is a quart of percent per year for ten years..and that quarter of percent needs to be broken down to a monthly percent
    So a year is .25/12=0.020834of a percent per month.
    So for five years would it be 0.020834 permonth for five years.
    12 months is a year for five years is sixty months.
    So maybe 0.020834*60=1.25% for the inflation for that five year period.

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