REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are

Question

REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are currently yielding 5 5%. 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 6% • Maturity risk premium = 1 8% • Default risk premium = 2 15% On the basis of these data, what is the real risk-free rate of return? Brigham, Eugene F.; Houston, Joel F.. Fundamentals of Financial Management (Finance Titles in the Brigham Family) (Page 213). South-Western College Pub. Kindle Edition.

Explanation / Answer

The T-bills in this case is short term treasury bonds, where only Inflation premium is added to the risk free rate to determine the yield on bonds.

r = r* + IP

5.5 = r* + 3.25

r* = 2.25%

Real risk free rate of return = 2.25%

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