Question

1.Assume that the real risk-free rate is 1.6% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5.8% and a 2-year Treasury bond yields 6.4%. Calculate the yield using a geometric average.

A.What is the 1-year interest rate that is expected for Year 2? Do not round intermediate calculations. Round your answer to two decimal places.

B.What inflation rate is expected during Year 2? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

	Solution:
	Risk free rate		1.60%
	Market Risk Premium		0
	r1=		5.80%
	r2=		6.40%
a)	1-Year interest rate =
	(1+r2)^2= (1+r1)(1+x)
	(1+0.064)^2=(1+0.058)(1+x)
	1.064^2=1.058(1+x)
	1.132096/1.058 = 1+ x
	(1.132096/1.058)-1 =x
	7.00	%
	1-Year interest rate = 7%
b)	Inflation rate
	1-year Interest rate =Risk free +2-year Interest rate
	7%=Risk Free + i2
	7%=1.6% +i2
	7%-1.6%
	5.4	%
	Inflation rate =5.4%

answered by: anonymous