Homework Answers
As per rules I am answering the first 4 subparts of the question
1: Average inflation =( 3%*3+4%)/4 = 3.25%
2: Yield on treasury bond= real risk-free rate+ inflation premium+ maturity risk premium
= 3%+3.25%+0.1*(4-1)%
=6.25%+0.3% = 6.55%
3: Yield on 4 year BB bond = real risk-free rate+ inflation premium+ maturity risk premium
+ DRP+Liquidity premium
= 6.55%+ 1.3%+ 0.4%
= 8.25%
4: Yield on 8 year Treasury = real risk-free rate+ inflation premium+ maturity risk premium
= 3%+ (3%*3+4%*5)/8 + 0.1*(8-1)%
= 3%+ 3.625%+ 0.7%
= 7.325%
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