Question

The real risk-free rate is 2.75%. Inflation is expected to be 1.75% this year and 4.00% 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.

  %

Answer 1

Solution :-

Real risk free rate = 2.75%

Inflation this year = 1.75%

Inflation for next 2 years = 4.00%

Maturity risk premium = 0

Yield on 2 year treasury securities

Before calculating yield , we have to calculate average inflation for 2 year

Inflation premium for 2 year =

= (1.75 % + 4.00%)/2

= 5.75% / 2

= 2.875%

Yield on 2 year treasury securities :-

= Real risk free rate + inflation premium + maturity risk premium

= 2.75% + 2.875% + 0

= 5.625 % or 5.63% (approx)

Yield on 3 - year treasury securities

We have to calculate average inflation premium for 3 year treasury securities

Average inflation premium for 3 years :-

=(1.75% + 4.00% + 4.00%) / 3

= 9.75% / 3

= 3.25%

Yield on 3 year treasury securities :-

= Real risk free rate + inflation premium + maturity risk premium

= 2.75% + 3.25 % + 0

= 6.00%