(Real interest rates: financial analyst\'s method) The CFO of your firm has aske

Question

(Real interest rates: financial analyst's method) The CFO of your firm has asked you for an approxiimate to this question. What was the increase in real purchasing power associated with both 3-month treasury bills and 30-year treasury bonds? assume that the current 3-month treasury bill rate is 4.34 percent, the 30-year treasury bond rate is 7.33 percent, and the inflation rate is 2.78 percent. Also, the chief financial officer wants a short explanation should the 3-month real rate turn out to be less than the 30-year real rate.

Explanation / Answer

According to the given information, Current 3-month Treasury Bill rate = 4.34% Current 30-year Treasury bond rate = 7.33% Inflation rate = 2.78% Calculating the increase in the Real purchasing power of the two securities: For Treasury Bill: Increase in Purchasing power = 3-Month Treasury bill rate - Inflation rate = 4.34% - 2.78% = 0.0434 - 0.0278 = 0.0156 or 1.56% Therefore, the increase in the purchasing power for 3-month Treasury bill is 1.56% For 30-Treasury bond: Increase in Purchasing power = 30-year Treasury bond rate - Inflation rate = 7.33% - 2.78% = 4.55% Therefore, the increase in the purchasing power for 30-year Treasury bond is 4.55% The 30-year is higher than the 3-month because of the risk with length of time of the investment.

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