Question
Suppose the rate of return on a 10-year T-bond is 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further
Suppose the rate of return on a 10-year T-bond is 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the expected average rate of inflation over the next 10 years is 2.0%, that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the real risk free rate of return, r*? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 1.80%
b. 2.10%
c. 1.70%
d. 2.00%
e. 1.90%
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