Suppose the inflation rate is expected to be 6.15% next year, 4.75% the followin

Question

Suppose the inflation rate is expected to be 6.15% next year, 4.75% the following year, and 2.75% thereafter. Assume that the real risk-free rate, r*, will remain at 1.55% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds. a.Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places. %

Explanation / Answer

For 1 year Treasury security; Real risk free rate =r*= 1.55% Maturity Risk premium=MRP 0.20% Inflation premium =IP= 6.15% Nominal Rate on 1 Year Treasury   Security=r*+IP+MRP=1.55%+0.2%+6.15%= 7.90% So 1 Year Treasury Security interest rate= 7.90%

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