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    Expected inflation

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    A 5-year corporate bond has an 8 percent yield. A 10-year corporate bond has a 9 percent yield. The two bonds have the same default risk premium and liquidity premium. The real risk-free rate, r*, is expected to remain constant at 3 percent. Inflation is expected to be 3 percent a year for the next five years. After five years, inflation is expected to be constant at some rate, X, which may or may not be 3 percent. The maturity risk premium equals 0.1(t - 1)%, where t equals time until the bond's maturity. In other words, the maturity risk premium on the five-year bond is 0.4 percent or 0.004.

    Showing the computation what is the market's expectation today of the average level of inflation for Years 6 - 10, i.e., what is X?

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    https://brainmass.com/business/bond-valuation/expected-inflation-61145

    Solution Preview

    A 5-year corporate bond has an 8 percent yield. A 10-year corporate bond has a 9 percent yield. The two bonds have the same default risk premium and liquidity premium. The real risk-free rate, r*, is expected to remain constant at 3 percent. Inflation is expected to be 3 percent a year for the next five years. After five years, inflation is expected to be constant at some rate, X, which may or ...

    Solution Summary

    The solution calculates market's expectation today of the average level of inflation for Years 6 - 10.

    $2.49

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