Interest Rate Premiums
A 5-year Treasury bond has a 3.4% yield. A 10-year Treasury bond yields 6.35%, and a 10-year corporate bond yields 9.8%. The market expects that inflation will average 1.8% over the next 10 years (IP10 = 1.8%). Assume 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: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described. What is the yield on this 5-year corporate bond? Round your answer to two decimal places.
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