Question & Answer: Question 5: Interest Rate Problems (2 parts, 10 points total)…..

Question 5: Interest Rate Problems (2 parts, 10 points total)

5a. The real risk-free rate of interest is 2%. Inflation is expected to be 3% the next two years and 5% during the three years after that. Assume that the maturity risk premium is zero. What is the (approximate) yield on 3-year Treasury securities? (Show all work.)

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5b. The real risk-free rate of interest is 2%. Inflation is expected to be 3% the next two years and 5% during the three years after that. Assume that the maturity risk premium is zero. What is the (approximate) yield on 5-year Treasury securities? (Show all work.)

Expert Answer

5a. r = r ^* + IP + MRP

2 + {( 3 + 3 + 5 ) / 3 } + 0 = 5.67 %

5b. r = r ^* + IP + MRP

2 + {( 3 + 3 + 5 + 5 + 5 ) / 5 } + 0 = 6.20 %

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