Assume investors expect a 2.0 percent real rate of return over the next year. If inflation is expected to be 0.5 percent, what is the expected market interest rate for a one-year U. S. Treasury security?

The correct answer is 2.5%

Explanation:

The rate of inflation is always factored in when calculating the expected market interest for a year.

From the example, the expected real rate of return/interest rate = 2.0 percent

Factoring in an expected 0.5% inflation rate,

= 2.0 + 0.5 = 2.5%

The expected market interest rate for a one-year U. S. Treasury Security = 2.5%