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A 1 year Treasury Security has a yield of 8%. The investor's expected annual rate of...

A 1 year Treasury Security has a yield of 8%.

The investor's expected annual rate of inflation is 4%.

However, the actual annual rate of inflation was 3%.

1. What is the expected real rate of interest?

2. What is the actual realized rate of interest?

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Answer #1

1. Expected real rate of interest = (1 + yield) / (1 + expected rate of inflation) - 1

Expected real rate of interest = (1 + 0.08) / (1 + 0.04) - 1

Expected real rate of interest = 1.0384615385 - 1 = 0.0384615385

Expected real rate of interest = 3.84615385%

2. Actual realized rate of interest = (1 + yield) / (1 + actual rate of inflation) - 1

Actual realized rate of interest = (1 + 0.08) / (1 + 0.03) - 1

Actual realized rate of interest = 1.0485436893 - 1 = 0.0485436893

Actual realized rate of interest = 4.85436893 %

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