Suppose you and most other investors expect the inflation rate to be 7% next yea
ID: 2734116 • Letter: S
Question
Suppose you and most other investors expect the inflation rate to be 7% next year, to fall to 5% during the following year, and then to remain at a rate of 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term securities (those that mature in a few days) to a level of 0.2 percentage points for 1-year securities. Furthermore, maturity risk premiums increase 0.2 percentage points for each year to maturity, up to a limit of 1.0 percentage point on 5-year or longer-term T-notes and T-bonds.
Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places.
%
Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places.
%
Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places.
%
Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places.
%
Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places.
%
Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places.
%
Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places.
%
Explanation / Answer
Inflation Rate 1 = 7 % (IF)
Inflation Rate 2 = 5 % (IF)
Inflation Rate 3 = 3 % (IF)
Rate * = 2 %
Market Risk Premium = MRP =02% = > 1% (year 5)
Year IF IP
1 7% 7%
2 5% 6%
3 3% 5%
4 3% 4.5%
5 3% 4.2%
10 3% 3.6%
20 3% 3.3%
Year r* IP MRP => r?
1 2% 7% 0.2% 9.2%
2 2% 6% 0.4% 8.4%
3 2% 5% 0.6% 7.6%
4 2% 4.5% 0.8% 7.3%
5 2% 4.2% 1.0% 7.2%
10 2% 3.6% 1% 6.6%
20 2% 3.3% 1% 6.3%