Suppose the rate of return on a 10-year T-bond is currently 5.00% and that on a

Question

Suppose the rate of return on a 10-year T-bond is currently 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

A. 1.80%

B. 1.90%

C. 2.00%

D. 2.10 %

E.  2.20%

Explanation / Answer

B. 1.90%

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