Suppose the inflation rate is expected to be 6.15% next year, 4.75% the followin

Question

Suppose the inflation rate is expected to be 6.15% next year, 4.75% the following year, and 2.75% thereafter. Assume that the real risk-free rate, r*, will remain at 1.55% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds. a.Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places. % b.Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places. % c.Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places. % d.Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places. % e.Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places. % f.Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places. % g.Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places. %

Explanation / Answer

=+E10+D10

Bond type Expected Annual Inflation rate Real risk free rate (r*) Average expected inflation rate or Inflation premium(IP) Average Nominal Interest r* rf= r*+IP 1 1st year bond 6.15% 1.55% 6.15% 7.70% 2 2nd year bond 4.75% 1.55% 5.45% 7.00% 3 3rd year bond 2.75% 1.55% 4.55% 6.10% 4 4th year bond 2.75% 1.55% 4.10% 5.65% 5 5th year bond 2.75% 1.55% 3.83% 5.38% 10 10th year bond 2.75% 1.55% 3.29% 4.84% 20 20th year bond 2.75% 1.55% 3.02% 4.57%

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