Q17

Suppose you and other investors expect that inflation will be 3% next year, to rise to 5% during the following year, and then to remain at 7.5% thereafter. Further, you expect that the real risk free rate of interest will remain at 2% and the maturity risk premium on treasury securities will rise from .2% for one year bonds. Maturity risk premiums are expected to increase 0.2% for each year to maturity up to a limit of 1.0 percentage point on 5-year or longer term T-bonds. What is the return on a 4-year bond? Write your answer as a decimal (i.e. 8% is 0.08)