a conventional one-year bank CD offering an interest rate of 7% and a one-year "Inflation-Plus" CD offering 3.5% per year plus the rate of inflation. a. Which is the safer investment? b. Which offers the higher expected return? c. If you expect the rate of inflation to be 3% over the next year, which is the better investment? Why? d. If we observe a risk-free nominal interest rate of 7% per year and a risk-free real rate of 3.5%, can we infer that the markets expected rate of inflation is 3.5% per year? 4. Look at Table 5.1 in the text. Suppose you now revise your expectations regarding the stock market as follows:     State of the Economy Probability Ending Price HPR   Boom .35 $140 44% Normal growth .30 110 14 Recession .35 80 -16     Use equations 5.1 and 5.2 to compute the mean and standard deviation of the HPR on stocks. Compare your revised parameters with the ones in the text. 5. Derive the probability distribution of the one-year HPR on a 30-year U.S. Treasury bond with an 8% coupon if it is currently selling at par and the probability distribution of its yield to maturity a year from now is as follows: I. Introduction 5. History of Interest Rates and Risk Premiums The McGraw−Hill Companies, 2001           CHAPTER 5 History of Interest Rates and Risk Premiums 147       State of the Economy Probability YTM   Boom .20 11.0% Normal growth .50 8.0 Recession .30 7.0