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1 March, 06:54

The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?

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  1. 1 March, 07:08
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    The yield on a 2-year treasury securities is 6.00%

    While the yield on 3-year treasury securities is 6.33%

    Explanation:

    Real-risk free rate = 3%

    Inflation is expected to be 2% this year and 4% during the next 2 years

    Also noting that maturity risk premium is zero

    As a result, the yield on 2-year treasury securities is computed:

    r = r * + IP + MRP

    r*=real-risk free rate=3%

    IP=average of this year inflation and that of two years' time

    MRP=market risk premium=0

    r = 3% + (2% + 4%) / 2 + 0

    r = 6%

    The yield of 3-year treasury securities is given thus:

    r = r * + IP + MRP

    r = 3% + (2% + 4% + 4%) / 3 + 0

    Note that the IP is now taking into consideration average of the three inflation figures given.

    r = 6.33%
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