Suppose that you read at the U.S. Treasury’s web site www.treasury.gov that 30-d

Question

Suppose that you read at the U.S. Treasury’s web site www.treasury.gov that 30-day T-bills currently are yielding 5.8%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

Inflation premium                = 3.25%

Liquidity premium               = 0.60%

Maturity risk premium       = 1.85%

Default risk premium          = 2.15%

TASK:     On the basis of the data above, please show well-labeled calculations for the real risk-free rate of return?

Explanation / Answer

nominal rate = real risk free rate+ all premiums given

5.8%= real risk free rate+ 3.25+0.6+1.85+2.15

real risk free rate= -2.05%

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