1. Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturity risk premium (MRP). Which of these premiums is included when determining the interest rate on (1) short-term U.S. Treasury securities, (2) long-term U.S. Treasury securities, (3) short-term corporate securities, and (4) long-term corporate securities? Explain how the premiums would vary over time and among the different securities.
2. What is the term structure of interest rates? What is a yield curve? At any given time, how would the yield curve facing a given company such as IBM or Microsoft compare with the yield curve for U.S. Treasury securities? Draw a graph to illustrate your answer.