12. The real risk-free rate is 3%, and inflation is expected to be 3% this year, 4% next year, and 3.5% thereafter. The maturity risk premium is estimated to be 0.05 X (t-1) % where t = number of years to maturity. What is the yield on a 7-year Treasury note?

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Business

Levi Cantu

23 March, 04:39

12. The real risk-free rate is 3%, and inflation is expected to be 3% this year, 4% next year, and 3.5% thereafter. The maturity risk premium is estimated to be 0.05 X (t-1) % where t = number of years to maturity. What is the yield on a 7-year Treasury note?

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Trevon Bautista · Answer 1

6.8%

Explanation:

Formula: r = r * + IP + MRP + DRP + LP.

Therefore:

r = Real risk-free rate + Inflation premium + Default risk premium + Liquidity premium

r * = 0.03

IP = 0.03+0.04=0.07

0.07+5*0.035=0.245

0.245/7=0.035

The maturity risk premium was provided in the problem as:

0.05 x (t - 1) %

MRP = 0.05 (7-1) %

= 0.05 (6%) = 0.0030

DRP = 0

LP = 0

Addition of all will be:

rt7 = 0.03 + 0.035 + 0.0030 = 0.068 = 6.8%

The yield on a 7-year Treasury note is 6.8%