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.
%
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%
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