Reference no: EM1310996

Calculation of Rate of Return using Pure Expectations Theory and calculation of real risk-free rate of return.

1. Suppose the real risk-free rate is 2.5% and the future rate of inflation is expected to be constant at 3.05%. What rate of return would you expect on a 5 year treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

a) 5.15%

b) 5.25%

c) 5.35%

d) 5.45%

e) 5.55%

1. 2. Assume that interest rates on 20 year treasury and corporate bonds are as follows:

T-Bond=7.72%

A= 9.64%

AAA = 8.72%

BBB = 10.18%

The differences in rates among these issues were caused primarily by:

a) Tax effects

b) Default risk differences

c) Maturity risk differences

d) Inflation differences

e) Real risk-free rate differences

1. 3. Suppose 1 year T-bills currently yield 5.0% and the future inflation rate is expected to be constant at 3.10% per year. What is the real risk-free rate of return, r*? Disregard cross-product terms, i.e. if averaging is required, use the arithmetic average.

a) 1.90%

b) 2.00%

c) 2.10%

d) 2.20%

e) ?