r 1 = 5.5% r 2 = 5.9% r 3 = 6.6% r 4 = 7.4% Assuming a constant real interest ra

Question

           r1 = 5.5%    r2 = 5.9%     r3 = 6.6%     r4 = 7.4%

Assuming a constant real interest rate of 2 percent, what are the approximate expected inflation rates for the next four years? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Consider the following spot interest rates for maturities of one, two, three, and four years.

           r1 = 5.5%    r2 = 5.9%     r3 = 6.6%     r4 = 7.4%

Assuming a constant real interest rate of 2 percent, what are the approximate expected inflation rates for the next four years? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places. Omit the "%" sign in your response.)

Explanation / Answer

Year 1

Average inflation rate= Spot rate - real risk free rate

                                          = 5.50% -2%

                                                =3.50%

Year 2

Average inflation rate= Spot rate - real risk free rate

(3.50% + Inflation 2)/2= 5.9% -2%

(3.50% + Inflation year 2) =          =7.80%

Inflation year 2 = 7.80% - 3.5% =4.30%

Year 3

Average inflation rate= Spot rate - real risk free rate

(3.50% + 4.30%+ Inflation 3)/3= 6.6% -2%

(7.80% + Inflation year 3) =          =13.80%

Inflation year 3 = 13.80%-7.8%

                                = 6%

Year 4

Average inflation rate= Spot rate - real risk free rate

(3.50% + 4.30%+6%+ Inflation 4)/4= 7.4% -2%

(13.80% + Inflation year 4) =       =21.60%

Inflation year 4 = 21.60% -13.80%

                                = 7.80%

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