Chapter 6-5

You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.4%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:

• Inflation premium = 2.50%
• Liquidity premium = 0.3%
• Maturity risk premium = 2.30%
• Default risk premium = 2.45%

On the basis of these data, what is the real risk-free rate of return? Round your answer to two decimal places.

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b) An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 6% and inflation is expected to be 10% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk? (Hint: Refer to "The Links Between Expected Inflation and Interest Rates: A Closer Look".) Round your answer to two decimal places.

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