Assume that the real risk-free rate,r*,is 4 percent,and that inflation is expected to be 9% in Year 1,6% in Year 2,and 4% thereafter.Assume also that all Treasury bonds are highly liquid and free of default risk.If 2-year and 5-year Treasury bonds both yield 12%,what is the difference in the maturity risk premiums (MRPs)on the two bonds,i.e. ,what is MRP₅ − MRP₂?

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The Fisher equation states that the nominal interest rate (i) is the sum of the real risk-free rate (r*) and the expected inflation rate (π), adjusted for the maturity risk premium (MRP) when dealing with Treasury bonds longer than one year. The equation can be represented as: i = r* + π + MRP.Given:- Real risk-free rate (r*) = 4%- Inflation Year 1 = 9%, Year 2 = 6%, Year 3 and beyond = 4%- 2-year and 5-year Treasury bonds yield = 12%First, calculate the expected inflation rates for the 2-year and 5-year periods using the given inflation rates. For the 2-year bond, the average expected inflation rate is (9% + 6%) / 2 = 7.5%. For the 5-year bond, the average expected inflation rate is (9% + 6% + 4% + 4% + 4%) / 5 = 5.4%.Using the Fisher equation, we can solve for the MRP of each bond by rearranging the equation to MRP = i - r* - π.For the 2-year bond:MRP_2 = 12% - 4% - 7.5% = 0.5%For the 5-year bond:MRP_5 = 12% - 4% - 5.4% = 2.6%The difference in the MRPs is:MRP_5 - MRP_2 = 2.6% - 0.5% = 2.1%Therefore, the difference in the maturity risk premiums on the two bonds is 2.1%.

Assume That the Real Risk-Free Rate,r*,is 4 Percent,and That Inflation