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EXPECTED INTEREST RATE The real risk-free rate is 2.3%. Inflation is expected to be 3.2% this year, 4.6% next year, and 2.45%

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Answer #1

Answer:

Real Risk-free Rate = 2.30%

Inflation Premium = Average Inflation Rate over 7 years
Inflation Premium = [3.20% + 4.60% + 2.45% * 5] / 7
Inflation Premium = 20.05% / 7
Inflation Premium = 2.86%

Maturity Risk Premium = 0.05 * (t - 1)%
Maturity Risk Premium = 0.05 * (7 - 1)%
Maturity Risk Premium = 0.30%

Yield on 7-year Treasury Note = Real Risk-free Rate + Inflation Premium + Maturity Risk Premium
Yield on 7-year Treasury Note = 2.30% + 2.86% + 0.30%
Yield on 7-year Treasury Note = 5.46%

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