Interest Rates 6

Determinants of Interest Rates

Suppose you and most other investors expect the inflation rate to be 7% next year, to fall to 5% 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.

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1. Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places.

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1. Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places.

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1. Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places.

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1. Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places.

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1. Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places.

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1. Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places.

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