Question

The real risk-free rate is 2.5%, and inflation is expected to be 3% for this year. and a 3.5%. during the next three years. Assume that the maturity risk premium is zero. What is the yield on 4-years treasury securities?

Answer 1

Sol:

Real risk-free rate = 2.5%

Expected inflation (I1)= 3% for the year

Expected inflation (I2) = 3.5% during the next three years

Maturity risk premium = 0

To determine yield (r) on 4-years treasury securities is as follows:

4-years yield (r) = Real risk-free rate + (I1 + I2 / 4) + Maturity risk premium

r = 2.5% + (3% + 3.5% + 3.5% + 3.5% / 4) + 0

r = 2.5% + (13.5% / 4) + 0

r = 2.5% + 3.375% = 5.875%

Therefore yield on 4-years treasury securities is 5.875%