The real risk-free rate of interest is 5%. Inflation is expected to be 2%, 3% of the next year and 4% during each of the...

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The real risk-free rate of interest is 5%. Inflation is expected to be 2%, 3% of the next year and 4% during each of the...

The real risk-free rate of interest is 5%. Inflation is expected to be 2%, 3% of the next year and 4% during each of the following years. Assume that the maturity risk premium is zero. What is the yield on 10-year Treasury Securities?

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Answer 1

Answer #1

Nominal yield on Treasury Bond = Real risk free rate + Inflation Premium + Inflation Premium

Inflation premium is average of inflation over life of bond.

For 10-year Treasury security, average inflation = [2% + 3% + (8 * 4%)]/10 = 3.70%

Nominal Yield = 5% + 3.70% + 0

Nominal Yield = 8.70%

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Answer 2

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