Question

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 5.90%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Answer 1

Answer:

The answer is 9.00%

Explanation:

real risk-free rate = 3.00%

average expected future inflation rate = 5.90%

Maturity risk premium = 0.10%

The expected rate of return on a 1 year treasury security would be = the average expected future inflation rate + maturity risk premium + real risk-free rate.

= 3.00% + 5.90% + 0.10%

= 9.00%