28. The real nsk-free rate is expected to remain constant at 3% in the future, a

Question

28. The real nsk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT? A. The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond. B. The yield on a 2-year T-bond must exceed that on a 5-year T-bond. C. The conditions in the problem cannot all be true-they are internally inconsistent. D. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond. E.

Explanation / Answer

28. The real risk free rate is expected to remain constant at 3%, a 2% rate od inflation is expected for the next 2 years, after which inflation is expected to increase to 4 % and there is a positive maturity risk premium that increases with with years to maturity. Given all this condition- option E is correct that the yeild on a 5 year treasury bond must exceed that on a 2 year treasury bond.

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