The real risk-free rate is 3%. Inflation is expected to be 4% this year and 5% next year. The maturity risk premium is estimated to be .20(t-1)%, where t is the number of years to maturity. What is the yield on a 2-year Treasury note?
Please explain steps, thank you.
Solution:
Real risk free rate = 3%
Inflation in year 1= 4%
Inflation in year 2= 5%
Maturity risk premium = .20(t-1)%
Maturity risk premium = .20(2-1)%= .20%
Yield on 2 year treasury note = Real risk free rate + average inflation premium + maturity risk premium
Yield on 2 year treasury note= 3% + (4% +5%) /2 + .20%= 7.70%
The real risk-free rate is 3%. Inflation is expected to be 4% this year and 5%...
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