Problem:
Absalom Motors's 9% coupon rate, semiannual payment, $1,000 par value bonds that mature in 10 years are callable 9 years from now at a price of $1,100. The bonds sell at a price of $1,520, and the yield curve is flat. Assuming that interest rates in the economy are expected to remain at their current level, what is the best estimate of the nominal interest rate on new bonds?
The real risk-free rate is 3%. Inflation is expected to be 3% this year, 5% next year, and then 4% thereafter. The maturity risk premium is estimated to be 0.0007 x (t - 1), where t = number of years to maturity. What is the nominal interest rate on a 7-year Treasury security? Explain in detail and provide step by step solution.