Reference no: EM132563616
Question A) Treasury securities that mature in 10 years currently have an interest rate of 14.7%. Inflation is expected to be 5% each of the next three years and 6% each year after the third year. The maturity risk premium is estimated to be 0.2%(t - 1), where t is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero). The real risk-free rate is assumed to be constant over time. What is the real risk-free rate of interest?
Question B) Assume that the expectations theory holds, and that liquidity and maturity risk premiums are zero. If the annual rate of interest on a 2-year Treasury bond is 14.8 percent and the rate on a 1-year Treasury bond is 16.3 percent, what rate of interest should you expect on a 1-year Treasury bond one year from now?
Question C) Assume that a 3-year Treasury note has no maturity premium, and that the real, risk-free rate of interest is 3 percent. If the T-note carries a yield to maturity of 15.9 percent, and if the expected average inflation rate over the next 2 years is 13.9 percent, what is the implied expected inflation rate during Year 3?
Question D) Assume that the current interest rate on a 1-year bond is 8 percent, the current rate on a 2-year bond is 15.9 percent, and the current rate on a 3-year bond is 13.9 percent. If the expectations theory of the term structure is correct, what is the difference between the 1-year interest rate expected during Year 3 and the current one year rate?
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