The real risk-free rate (r*) is 2.8% and is expected to remain constant. Inflation is expected to be 5% per year for each of the next three years and 4% thereafter.
The maturity risk premium (MRP) is determined from the formula: 0.1(t – 1)%, where t is the security’s maturity. The liquidity premium (LP) on all National Transmissions Corp.’s bonds is 0.55%. The following table shows the current relationship between bond ratings and default risk premiums (DRP):
Rating
Default Risk Premium
U.S. Treasury —
AAA 0.60%
AA 0.80%
A 1.05%
BBB 1.45%
National Transmissions Corp. issues thirteen-year, AA-rated bonds. What is the yield on one of these bonds? Disregard cross-product terms; that is, if averaging is required, use the arithmetic average.

8.38%
5.35%
9.58%
9.03%
Based on your understanding of the determinants of interest rates, if everything else remains the same, which of the following will be true?

A BBB-rated bond has a lower default risk premium as compared to an AAA-rated bond.
An AAA-rated bond has less default risk than a BB-rated bond.