a.

Risk free rate of interest applicable to each security:

A: Real rate + inflation = 2%+9% = 11%

B: Real rate + inflation = 2%+7% = 9%

b. Find the total risk premium

A: 1%+1%+0.5%+0.5% = 3%

B: 1%+2+1.5%+1.5% = 6%

c. Nominal rate of interest

A: 11%-3% = 8%

B: 9%-6% = 2%

The nominal rate on B is 1.0% higher than A. While B has a greater risk premium priced into it
(6% vs. 3%), this is tempered by the lower inflation premium (7% vs. 9%).