A Treasury note with a maturity of four years carries a nominal rate of interest

Question

A Treasury note with a maturity of four years   carries a nominal rate of interest of 10%. In contrast, an eight-year Treasury   bond has a yield of 8%. a.] If   inflation is expected to average 7 percent over the first four years, what is   the expected real rate of interest? b.] If the   inflation rate is expected to be 5 percent for the first year, calculate the   average annual rate of inflation for years 2   through 4. c.] If the   maturity risk premium is expected to be zero between the two Treasury   securities, what will be the average annual   inflation rate expected over years 5 through 8? A Treasury note with a maturity of four years   carries a nominal rate of interest of 10%. In contrast, an eight-year Treasury   bond has a yield of 8%. a.] If   inflation is expected to average 7 percent over the first four years, what is   the expected real rate of interest? b.] If the   inflation rate is expected to be 5 percent for the first year, calculate the   average annual rate of inflation for years 2   through 4. c.] If the   maturity risk premium is expected to be zero between the two Treasury   securities, what will be the average annual   inflation rate expected over years 5 through 8?

Explanation / Answer

a).10-7=3 for the first 8-7=1 for the second.

b). well we need all 4 to be 28% (7*4). So if the first is 5% we need 23% for the other 3.

23/3=7.666% for the other 3.

c). the yield curve must be flat, so the made 3% interest yearly. So we need all 8 years to average 3%. The first 4 averaged 1%, which means to get 3% the next 4 have to be 5% (5+1 /2 = 3). So the nominal return is 8%, the real is 5%, so 8-5=3% average annual interest rate.

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