Question text

Suppose that investors expect the yearly rate of inflation to be 5% the first year, 4% the following year, 3% the following year, and then to remain at a rate of 2% thereafter. Assume that the real risk free rate r* is 3%. Assume that the default risk premium (DRP) is at 0.2% for the first year and increases by 0.1% every year thereafter. Assume also that there is no maturity risk premium (MRP) and no liquidity premium (LP).

Calculate the interest rate on a 1-, 2-, 3-, 4-, 5-, and 10- year Treasury security.

(Hint: Please use the table format we went over in class to get these interest rates. Remember the formula: r = r* + IP + DRP + MRP + LP)

Please make sure each answer is in 2 decimal places after the decimal point.

The 1-year Treasury rate isAnswer

%

The 2-year Treasury rate isAnswer

%

The 3-year Treasury rate isAnswer

%

The 4-year Treasury rate isAnswer

%

The 5-year Treasury rate isAnswer

%

The 10-year Treasury rate isAnswer

%