Question

# The real risk-free rate is 3%. Inflation is expected to be 1.5% this year and 3.5%...

The real risk-free rate is 3%. Inflation is expected to be 1.5% this year and 3.5% during the next 2 years. Assume that the maturity risk premium is zero.

What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.

%

What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.

%

Solution:-

Given,

Real risk free rate = 3%

Inflation premium for year 1 = 1.5%

Inflation premium for years 2 and 3 = 3.5%

Yield on 2-year treasury securities:

r = real risk free rate + inflation premium + market risk premium

= 3% + (1.5%+3.5% / 2

= 3% + 5%/2

= 3% + 2.5%

= 5.5%

Yield on 3-year treasury securities:

r = 3% +(1.5% + 3.5% + 3.5%) / 3

= 3% + 8.5% /3

= 3% + 2.833%

= 5.833%

Therefore the yield on 2-year treasury securities is 5.50%

the yield on 3-year treasury securities is 5.83%

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