problem: A 5-year Treasury bond consists of a 5.2 % yield. A 10-year Treasury bond yields 6.4%, and a 10-year corporate bond yields 8.4%. The market expects that the inflation will average 2.5 % over the next 10 years (IP10 = 2.5%). Suppose that there is no maturity risk premium (MRP = 0) and that the annual real risk free rate, r*, will remain constant over the next 10 years.
(Hint: Keep in mind that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.)
A 5-year corporate bond consists of the same default risk premium and liquidity premium as 10-year corporate bond describeed above. Illustrate the yield on this 5-year corporate bond?