Determinants of Interest Rates

Suppose you and most other investors expect the inflation rate to be 8% next year, to fall to 4% during the following year, and then to remain at a rate of 3% thereafter. Assume that the real risk-free rate, r*, will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term securities (those that mature in a few days) to a level of 0.2 percentage points for 1-year securities. Furthermore, maturity risk premiums increase 0.2 percentage points for each year to maturity, up to a limit of 1.0 percentage point on 5-year or longer-term T-notes and T-bonds.

1. Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places.
2. %
3. Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places.
4. %
5. Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places.
6. %
7. Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places.
8. %
9. Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places.
10. %
11. Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places.
12. %
13. Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places.
14. %

Assume that the real risk-free rate, r*, is 2% and that inflation is expected to be 7% in Year 1, 6% in Year 2, and 3% thereafter. Assume also that all Treasury securities are highly liquid and free of default risk. If 2-year and 5-year Treasury notes both yield 10%, what is the difference in the maturity risk premiums (MRPs) on the two notes; that is, what is MRP5minus MRP2? Round your answer to two decimal places.

The real risk-free rate is 4%. Inflation is expected to be 4% this year, 3% next year, and then 4.5% thereafter. The maturity risk premium is estimated to be 0.0003 x (t - 1), where t = number of years to maturity. What is the nominal interest rate on a 7-year Treasury security? Round your answer to two decimal places.