Assume that a 3-year Treasury note has no maturity premium, and that the real, risk-free rate of interest is 3 percent.

Assume that a 3-year Treasury note has no maturity premium, and that the real, risk-free rate of interest is 3 percent. If the T-note carries a yield to maturity of 15.9 percent, and if the expected average inflation rate over the next 2 years is 13.9 percent, what is the implied expected inflation rate during Year 3?

Expert Solution

Inflation premium = Nominal risk free rate - Real risk free rate
= 15.9% - 3%
= 12.9%

Inflation premium = ((Expected average inflation rate over the next 2 years * 2) + Inflation rate during year3) / 3

12.9% = ((13.9% * 2) + Inflation rate during year 3) / 3
12.9% * 3 = 27.8% + Inflation rate during year 3

38.7% = 27.8% + Inflation rate during year 3

Inflation rate during year 3 = 38.7% - 27.8% = 10.9%

Inflation rate during year 3 = 10.9%

jeff jeffy answered 2 years ago

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