Question

The real risk-free rate is 2.00%, and inflation is expected to be 3.25% for the next 2 years. A 2-year Treasury security yields 8.50%. What is the maturity risk premium for the 2-year security? Round your answer to two decimal places.

Answer 1

As per fisher theory, Nominal yield = ((1+real risk free rate)*(1+Inflation rate))-1

((1+2%)*(1+3.25%))-1

=0.05315 or 5.315%

Treasury security yield for 2 year is equal to Nomianl yield + Maturity risk premium

8.50% = 5.315% + Maturity risk premium

Maturity risk premium = 8.50%-5.315%

3.185% or 3.19%

So Maturity risk premium on 2 year security is 3.19%

Note: Fisher formula also states, Nominal yield = Risk free + Inflation rate

2%+3.25%

=5.25%

As per this, Maturity Risk premium = 8.50%-5.25%

=3.25%