Add the IPs and MRPs to k* to find the appropriate

nominal rates
Step 3 – Adding the premiums to k*.

kRF, t = k* + IPt + MRPt

Assume k* = 3%,
kRF, 1 = 3% + 5.0% + 0.0% = 8.0%
kRF, 10 = 3% + 7.5% + 0.9% = 11.4%
kRF, 20 = 3% + 7.75% + 1.9% = 12.65%
Hypothetical yield curve
Interest • An upward sloping
Rate (%)
yield curve.
15 Maturity risk premium
• Upward slope due to
an increase in
10 Inflation premium
expected inflation and
increasing maturity
5 risk premium.
Real risk-free rate
0 Years to
1 10 20 Maturity
 What is the relationship between the Treasury yield
curve and the yield curves for corporate issues?
• Corporate yield curves are higher than that of Treasury securities,
though not necessarily parallel to the Treasury curve.
• The spread between corporate and Treasury yield curves widens as
the corporate bond rating decreases.
Illustrating the relationship between corporate and
Treasury yield curves
Interest
Rate (%)
15

BB-Rated
10
AAA-Rated
Treasury
6.0% Yield Curve
5 5.9%
5.2%

Years to
0 Maturity
0 1 5 10 15 20