Question

EXPECTED INTEREST RATE

The real risk-free rate is 2%. Inflation is expected to be 1.5% this year and 3.75% during the next 2 years. Assume that the maturity risk premium is zero.

1. What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.
   
   %
   
2. What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.
   
   %

Answer 1

What is the yield on 2-year Treasury securities

r = r* + IP + MRP

            r = 2 + ((1.5+3.75)/2) + 0

            r = 4.625%

What is the yield on 3-year Treasury securities

r = r* + IP + MRP

            r = 2 + ((1.5+3.75+3.75)/3) + 0

            r = 5%