P6–6 Nominal and real rates and yield curves A firm wishing to evaluate interest rate behavior has gathered data on the nominal rate of interest and on inflationary expectations for five U.S. Treasury securities, each having a different maturity and each measured at a different point in time during the year just ended. (Note: Assume that the risk that future interest rate movements will affect longer maturities more than shorter maturities is zero; that is, assume that there is no maturity risk.) These data are summarized in the following table.

a. Using the preceding data, find the real rate of interest at each point in time.

b. Describe the behavior of the real rate of interest over the year. What forces might be responsible for such behavior?

c. Draw the yield curve associated with these data, assuming that the nominal rates were measured at the same point in time.

d. Describe the resulting yield curve in part

c, and explain the general expectations embodied in it.

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U.S. Treasury security Point in time Maturity of interest Nominal rate Inflationary expectation A Jan. 7 2 years 12.6% 9.5% B Mar. 12 10 years 11.2 8.2 C May 30 6 months 13.0 10.0 D Aug. 15 20 years 11.0 8.1 E Dec. 30 5 years 11.4 8.3