Question

The Wall Street Journal reports that the rate on 3-year Treasury securities is 8.60 percent, and the 6-year Treasury rate is 8.65 percent. From discussions with your broker, you have determined that expected inflation premium is 3.90 percent next year, 4.15 percent in Year 2, and 4.35 percent in Year 3 and beyond. Further, you expect that real interest rates will be 4.20 percent annually for the foreseeable future. What is the maturity risk premium on the 6-year Treasury security?

Answer 1

Given,

6-year treasury rate = 8.65%

Inflation premium in year 3 = 4.35%

Real interest rate = 4.20%

Solution :-

Let maturity risk premium on the 6-year treasury security be MRP₆

6-year treasury rate = Inflation premium in year 3 + real interest rate + MRP₆

8.65% = 4.35% + 4.20% + MRP₆

8.65% = 8.55% + MRP₆

8.65% - 8.55% = MRP₆

0.10% = MRP₆

Thus, maturity risk premium on the 6-year treasury security is 0.10%