problem1: Suppose that interest rates on twenty year treasury and corporate bonds are as follows:

T-Bond=7.72%

A= 9.64%

AAA = 8.72%

BBB = 10.18%

The differences in rates among these issues were caused primarily by:

[A]    Maturity risk differences

[B]   Inflation differences

[C]    Real risk-free rate differences

[D]    Tax effects

[E]   Default risk differences

problem2:  Assume one year T-bills currently yield 5.0 percent and the future inflation rate is expected to be constant at 3.10 percent per year.  determine the real risk-free rate of return, r*?  Disregard cross-product terms, i.e. if averaging is required, apply the arithmetic average.

[A]    2.10%

[B]   2.20%

[C]    1.90%

[D]   2.00%

problem3. Assume the real risk-free rate is 2.5 percent and the future rate of inflation is expected to be constant at 3.05 percent. Determine the rate of return would you expect on a five year treasury security, suppose the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

[A]    5.35%

[B]   5.45%

[C]    5.55%

[D]    5.15%

[E]   5.25%