The real risk-free rate of interest is 3%. Inflation is expected to be 2% this year...

The real risk-free rate of interest is 3%. Inflation is expected to be 2% this year and 3% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities?

(If financial calculator is used show those computations and show ALL work)

Solutions

Expert Solution

r = r* + IP + MRP + DRP + LP

r = risk free rate + Inflation prmeium + Maturity risk premium + Default risk prmeium + Liquidity premium

Rea; risk free rate = 3%

Maturity risk premium = 0

Inflation premium for 2 years = Average of Inflation premium in year 1 and 2

Inflation premium for 2 years = (2% + 3%)/ 2

Inflation premium for 2 years = 2.5%

rT2 = 3% + 2.5%

rT2 = 5.5%

jeff jeffy answered 1 year ago

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