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For the next four years, inflation is expected to be 3% annually. For the four years...

For the next four years, inflation is expected to be 3% annually. For the four years after that, it is expected to be 4% annually.

a) Calculate the inflation premium for a bond maturing in 6 years. Show your work in exquisite detail. Express the answer in % to 2 decimal places.

b) Calculate the inflation premium for a bond maturing in 8 years. Show your work. Express the answer in % to 2 decimal places.

c) [review] Express the answer in b) above in bps

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Homework Answers

Answer #1

Answer a.

inflation for first 4 years is 3% and 4% for next 2 years

Inflation Premium = (Sum of Inflation Rate over period) / Number of of years
Inflation Premium = (3% + 3% + 3% + 3% + 4% + 4%) / 6
Inflation Premium = 3.33%

Answer b.

inflation for first 4 years is 3% and 4% for next 4 years

Inflation Premium = (Sum of Inflation Rate over period) / Number of of years
Inflation Premium = (3% + 3% + 3% + 3% + 4% + 4% + 4% + 4%) / 8
Inflation Premium = 3.50%

Answer c.

Inflation Premium for a bond maturing in 8 years is 3.50%

Inflation Premium = 3.50%
Inflation Premium = 350 bps

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