A 2-year Treasury security currently earns 1.67 percent. Over the next two years

Question

A 2-year Treasury security currently earns 1.67 percent. Over the next two years, the real risk-free rate is expected to be 1.00 percent per year and the inflation premium is expected to be 0.40 percent per year. Calculate the maturity risk premium on the 2-year Treasury security.

A 2-year Treasury security currently earns 1.67 percent. Over the next two years, the real risk-free rate is expected to be 1.00 percent per year and the inflation premium is expected to be 0.40 percent per year. Calculate the maturity risk premium on the 2-year Treasury security.

Explanation / Answer

Rate of Return = 1.67%
Real Risk-free Rate = 1.00%
Inflation Premium = 0.40%

Rate of Return = Real Risk-free Rate + Inflation Premium + Maturity Risk Premium
1.67% = 1.00% + 0.40% + Maturity Risk Premium
Maturity Risk Premium = 0.27%

So, market risk premium on the 2-year Treasury security is 0.27%

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