Question

The real risk-free rate, r*, is 4%, and it is expected to remain constant over time. Inflation is expected to be 2% per year for each of the next three years, after which time inflation is expected to remain at a constant rate of 5% per year. The maturity risk premium is equal to 0.1(t - 1)%, where t = the bond’s maturity. What is the yield on a 10-year Treasury bond?

Answer 1

Answer:- The following details are given as

The real risk-free rate, r*= 4%

The maturity risk premium is equal to 0.1(t - 1)% where t = the bond’s maturity

Inflation is expected to be 2% per year for each of the next three years, after which time inflation is expected to remain at a constant rate of 5% per year

We have to find the yield on a 10-year Treasury bond

We know that Yield = Real Risk-Free Rate + Maturity Risk Premium + Inflation Rate

Now we have to find the Inflation rate for 10 years

Inflation rate for 10 years = (2% + 2% + 2% + 5% + 5% +5% + 5% + 5% + 5% + 5%)/10 = 4.1%

The yield on a 10-year Treasury bond = Real Risk-Free Rate + Maturity Risk Premium + Inflation Rate

= 4% + 0.1(10- 1)% + 4.1%

= 4% + 0.9% + 4.1%

= 9.0%