Question

b. If the 1-year Treasury bill rate on January 17, 2018 is 1.77% and the inflation

expectation for the coming year is 1.90%, what is the expected real rate of return

for an investor who purchases the 1-year Treasury bill?

Expected Real Rate of Return _______________

c.If an investor desires a real rate of return of 2% and expects inflation to be 2%

next year, what nominal rate should the investor demand?

Nominal Rate Investor Demands _______________

Answer 1

Remember this Relationship;

(1 + Nominal Rate of return) = (1 + Real Rate of return) (1 + Inflation Rate)

b.) Inflation Rate = 1.90%

Nominal Rate = 1.77%

Therefore,

(1.0177) = (1 + Real Rate of retun) (1.019)

1 + Real Rate of return = 1.0177/1.019

Real rate of return = .9987 - 1 = -0.128%

[Yes, real rate of return can be negative]

c.) (1 + Nominal rate) = (1 + Real rate of return)(1+ Inflation Rate)

(1 + Nominal Rate) = (1.02)(1.02)

Nominal Rate = 1.0404 - 1 = 4.04%