Question

1)

The risk free rate on treasury bills is 2.40%. Inflation is 1.3%. What is the real rate of return on treasury bills?

Meaning of what is the "real rate of return" ?

If investor saw calculated number two from above, would he be pleased or not?

2)

The nominal return on treasury bonds is 2.7%, the maturity risk premium is 0.2%. Real return can earn 0.3%.

What is the inflation premium?

Why is there maturity risk premium on US treasury bonds vs. bills?

Answer 1

1)

Nominal Risk free rate = 2.40%

Inflation rate = 1.3%

Real rate of return = (1+nominal rate)/(1+ inflation ) -1

= (1+2.4%)/(1+1.3%) -1 = 1.085%

The investor would not be pleased looking at the above numbers as the nominal figures would have tricked him/her into believing that it is the real rate.

2)

Nominal return on Treasury bonds = 2.7%

Real risk free rate = 0.3%

Maturity risk premium = 0.2%

Nominal return = Real risk free rate + Inflation premium + Maturity risk premium

Inflation premium = 2.7%-(0.3%+ 0.2%) = 2.2%