1. You are considering an investment in a one-year government debt security with a yield of 4.5 percent or a highly liquid corporate debt security with a yield of 7.25 percent. The expected inflation rate for the next year is expected to be 3 percent.
a) What would be your real rate earned on either of the two investments?
b) What would be the default risk premium on the corporate debt security?
2. A Treasury note with a maturity of four years carries a nominal rate of interest of 11.5 percent. In contrast, an 8-year Treasury bond has a yield of 7.5 percent.
a) If inflation is expected to average 6 percent over the first four years, what is the expected real rate of interest?
b) If the inflation rate is expected to be 4.5 percent for the first year, calculate the average annual rate of inflation for years two through four.
3. The real rate is 2.5%. Inflation is expected to be 3.25% this year and 1.5% during the next 2 years. Assume the maturity risk premium is 0. What is the yield on 3-year Treasury securities?