(6-18) DETERMINANTS OF INTEREST RATES The real risk-free rate is 2%. Inflation is expected to be 3% this year, 4% next year, and 3.5% thereafter. The maturity risk premium is estimated to be 0.0005 (t-1), where t = number of years to maturity. What is the nominal interest rate on a 7-year government security? (Hint: Average the expected inflation rates to determine the inflation premium, IP.) 4

(6-18) DETERMINANTS OF INTEREST RATES The real risk-free rate is 2%. Inflation is expected to be 3% this year, 4% next year, and 3.5% thereafter. The maturity risk premium is estimated to be 0.0005(t1), where t= number of years to maturity , What is the nominal interest rate on a 7-year government security? (Hint: Average the expected inflation rates to determine the inflation premium, IP.)