Question

Expected Interest Rate

The real risk-free rate is 2.25%. Inflation is expected to be 1.75% this year and 4.5% during the next 2 years. Assume that the maturity risk premium is zero.

a. What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. _______%

b. What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. _______%

Answer 1

a. r = real risk free rate + Inflation Premium + Market risk premium

            r = 2.25 + ((1.75+4.5)/2) + 0

            r = 5.38%

yield on 3yr bond

b. r = real risk free rate + Inflation Premium + Market risk premium

            r = 2.25 + ((1.75+4.5 + 4.5)/3) + 0

            r =5.83%