A corporate bond has a nominal interest rate of 12 percent. This bond is not very liquid and consequently requires a 2 percent liquidity premium. The bond is of low quality and thus has a default risk premium of 2.5 percent. The bond has a remaining life of twenty-five years, resulting in a maturity risk premium of 1.5 percent.
a. Estimate the nominal interest rate on a Treasury bond.
b. What would be the inflation premium on the Treasury bond if investors required a real rate of interest of 2.5 percent?