Suppose economists have determined that the real risk-free


Suppose economists have determined that the real risk-free rate of return is 3 percent and that inflation is expected to average 2.5 percent per year long into the future. A 1-year Treasury note offers a rate of return equal to 5.5 percent. You are evaluating two corporate bonds: (1) Bond A has a rate of return, rA, equal to 8 percent; (2) Bond B has a rate of return, rB, equal to 7 percent. Except for their maturities, these bonds are identical--Bond A matures in 10 years, whereas Bond B matures in 5 years. You have determined that both bonds are very liquid, and thus neither bond has a liquidity premium. a) Assuming that there is an MRP for bonds with maturities equal to 1 year or greater, compute the annual MRP. b) What are the DRP associated with Bond A and Bond B, respectively?

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Financial Management: Suppose economists have determined that the real risk-free
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