(Solved): 9. Calculating interest rates The real risk-free rate (r) is 2.8% and is expected to remain con ...

9. Calculating interest rates The real risk-free rate $$\left(r^{?}\right)$$ is $$2.8\%$$ and is expected to remain constant. Inflation is expected to be $$4\%$$ per year for each of the next two years and $$3\%$$ thereafter. The maturity risk premium (MRP) is determined from the formula: $$0.1(\mathrm{t}?1)\%$$, where $$t$$ is the security's maturity. The liquidity premium (LP) on all Smith and Carter Inc.'s bonds is $$0.55\%$$. The following table shows the current relationship between bond ratings and default risk premiums (DRP): Smith and Carter Inc. issues 10 -year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average. $$\begin{array}{l}7.35\%\\ 8.25\%\\ 5.05\%\\ 7.70\%\end{array}$$ Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true? In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity. The yield on a AAA-rated bond will be higher than the yield on a BB-rated bond.