Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
A. The yield curve for U.S. Treasury securities will be upward sloping.
B. A 5-year corporate bond must have a lower yield than a 5-year Treasury security.
C. A 5-year corporate bond must have a lower yield than a 7-year Treasury security.
D. The real risk-free rate cannot be constant if inflation is not expected to remain constant.
E. This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
Answer: E
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c. 243
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