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A 5-year Treasury bond has a 3.65% yield. A 10-year Treasury bond yields 6.9%, and a 10-year corporate bond yields 8.85%. The market expects that inflation will average 3.6% over the next 10 years (IP10 = 3.6%). Assume that there is no maturity risk premium (MRP = 0) and that the annual real risk-free rate, r*, will remain constant over the next 10 years. (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) A 5-year corporate bond has the same default risk premium and liquidity premium as the 10-year corporate bond described.

What is the yield on this 5-year corporate bond? Round the answer to two decimal places.

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\begin{tabular}{|c|c|c|} \hline & A & B \\ \hline 1 & Interest rate premiums & \\ \hline 2 & & \\ \hline 3 & 5-year Treasury yield (T5) & 3.65% \\ \hline 4 & 10-year Treasury yield (T10) & 6.90% \\ \hline 5 & 10-year Corporate yield (C10) & 8.85% \\ \hline 6 & Inflation Premium over 10 years (IP10) & 3.60% \\ \hline 7 & Maturity Risk Premium (MRP) & 0.00% \\ \hline 8 & DRP Treasury & 0.00% \\ \hline 9 & LP Treasury & 0.00% \\ \hline 10 & DRPC5+LPC5=DRPC10+LPC10 & \\ \hline 11 & & \\ \hline 12 & Real risk-free rate, r & \\ \hline 13 & & 4 \\ \hline 14 & Inflation premium over 5 years (IP5) & \\ \hline 15 & & \\ \hline 16 & DRP10+LPP10 & \\ \hline 17 & & \\ \hline 18 & 5-year Corporate yield (C5) & \\ \hline \end{tabular}

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