Question

Due to a recession, expected inflation this year is only 3%. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume that the expectations theory holds and the real risk-free rate (r*) is 3.5%. If the yield on 3-year Treasury bonds equals the 1-year yield plus 3.5%, what inflation rate is expected after Year 1? Round your answer to two decimal places.

Answer #1

Under Pure expectations theory and For Treasury bonds, default risk
premium and liquidity risk premium are zero..Also, maturity risk
premium=0

rate on 1year TBond=real rate+inflation premium

Hence, rate on 1 year Treasury bond=3.5%+3%=6.5%

rate on 3 year Treasury bond is given as 6.5%+3.5%=10%

=>3.5%+Average Inflation premium=10%

So, average inflation premium=6.5%

=>Inflation Premium 1+Inflation Premium 2 + Inflation Premium
3=6.5*3=19.5%

Now we know Inflation Premium 1=3.5% and Inflation Premium
2=Inflation Premium 3

So, Inflation Premium 2=(19.5%-3.5%)/2=8%

Due to a recession, expected inflation this year is only 2.75%.
However, the inflation rate in Year 2 and thereafter is expected to
be constant at some level above 2.75%. Assume that the expectations
theory holds and the real risk-free rate (r*) is 3.5%. If the yield
on 3-year Treasury bonds equals the 1-year yield plus 3.5%, what
inflation rate is expected after Year 1? Round your answer to two
decimal places.
%

Due to a recession, expected inflation this year is only 2.75%.
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on 3-year Treasury bonds equals the 1-year yield plus 1.0%, what
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However, the inflation rate in Year 2 and thereafter is expected to
be constant at some level above 2.5%. Assume that the expectations
theory holds and the real risk-free rate (r*) is 3%. If the yield
on 3-year Treasury bonds equals the 1-year yield plus 3%, what
inflation rate is expected after Year 1? Round your answer to two
decimal places.

Due to a recession, expected inflation this year is only 2.5%.
However, the inflation rate in Year 2 and thereafter is expected to
be constant at some level above 2.5%. Assume that the expectations
theory holds and the real risk-free rate (r*) is 3%. If the yield
on 3-year Treasury bonds equals the 1-year yield plus 3%, what
inflation rate is expected after Year 1? Round your answer to two
decimal places.

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However, the inflation rate in Year 2 and thereafter is expected to
be constant at some level above 2.75%. Assume that the expectations
theory holds and the real risk-free rate (r*) is 3%. If the yield
on 3-year Treasury bonds equals the 1-year yield plus 3%, what
inflation rate is expected after Year 1? Round your answer to two
decimal places.

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However, the inflation rate in Year 2 and thereafter is expected to
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However, the inflation rate in Year 2 and thereafter is expected to
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on 3-year Treasury bonds equals the 1-year yield plus 0.5%, what
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However, the inflation rate in Year 2 and thereafter is expected to
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However, the inflation rate in Year 2 and thereafter is expected to
be constant at some level above 3.75%. Assume that the expectations
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