Question

5-year Treasury bonds yield 4.4%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*?

Answer 1

Answer:

The real risk-free rate is 2.1%

Explanation:

Typically, the return on investment is denoted by the below formula:

return on investment=real  risk-free rate+inflation premium+default risk premium+liquidity premium+maturity premium

return on investment is 4.4%

inflation premium is 1.9%

maturity risk premium is 0.4%

liquidity premium is 0%

default risk is also assumed to zero as the treasury bond is backed by the government whose level of default is zero

real risk-free rate=return on investment-inflation premium-default risk-liquidity premium-maturity premium

real risk-free rate=4.4%-1.9%-0%-0%-0.4%

real risk-free rate=2.1%