A thirty- year U. S. Treasury bond has a 4.0 percent interest rate. In contrast,

Question

A thirty- year U. S. Treasury bond has a 4.0 percent interest rate. In contrast, a ten- year Treasury bond has an interest rate of 2.5 percent. A maturity risk premium is estimated to be 0.2 percentage points for the longer maturity bond. Investors expect inflation to average 1.5 percentage points over the next ten years. a. Estimate the expected real rate of return on the ten- year U. S. Treasury bond. b. If the real rate of return is expected to be the same for the thirty- year bond as for the ten- year bond, estimate the average annual inflation rate expected by investors over the life of the thirty- year bond.

Explanation / Answer

10 year bond nominal rate = real rate + inflation, so real rate = nominal rate - inflation

real rate = 2.5%-1.5% = 1%

30 year bond: Nominal rate = real rate + inflation + risk premium

So inflation = nominal rate - real rate - risk premium

= 4% - 1% - 0.2% = 2.8%

Hope this helped ! Let me know in case of any queries.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.