D Chapter 6. Interest Rates 3 9 PARTE Suppose most investors expect the inflation rate to be 5% next year, 6% the following year, and 8% thereafter. The real risk-free rate is 3%. The maturity risk premium is zero for bonds that mature in 1 year or less and 0.1% for 2-year bonds; then the MRP increases by 0.1% per year thereafter for 20 years, after which it is stable. What is the interest rate on 1, 10, and 20-year Treasury bonds? Draw a yield curve with these data. What factors can explain why this 7 constructed yield curve is upward sloping? 8 9 INPUT DATA 10 Real risk-free rate 3% 11 12 Expected inflation of 5% 13 Expected inflation of 6% 14 Expected inflation of 8% 0.10% 15 16 MRP of 17 18 Maturity (in years) 19 1-year Treasury yield 20 1-year Treasury yield 1 1-year Treasury yield for the next year. for the following year. thereafter. for each year after = 1 = r + IP1 + MRP1 3.00% + 5.00% + 0.00% 23 Maturity (in years) 10 24 10-year Treasury yield r + IP 10 + MRP 10 25 10-year Treasury yield 3% + 7.50% + 0.90% 26 10-year Treasury yield- 27 28 Maturity (in years) 29 20-year Treasury yield 30 20-year Treasury yield 31 20-year Treasury yield= 32 20 21 + IP20 + MRP 20 3% + 7.75% + 1.90% 33 34 35 Yield Curve Interest rate 36 37 15% 38 12% 39 9% 40 41 6% 42 3% 43 0% 44 0 5 10 15 20 45 20 46 Years to maturity 47 48 06 Case model 49 50 31 52 53 PART H 20