Answer Happy

3. Calculating interest rates The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 5% per year for each of the next two years and 4% thereafter. The maturity risk premium (MRP) is determined from the formula: 0.1(t - 1)%, where t is the security's maturity. The liquidity premium (LP) on all Smith and Carter Inc.'s bonds is 1.05%. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Default Risk Premium Rating U.S. Treasury AAA 0.60% АА 0.80% A 1.05% BBB 1.45% Smith and Carter Inc. issues 11-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. O 5.65% O 8.83% O 9.83% O 8.78% Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? The yield on an AAA-rated bond will be higher than the yield on a BB-rated bond. In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity.