Question

A 30-year U.S. Treasury bond has a 4.0 percent interest rate. In contrast, a 10-year Treasury note has an interest rate of 2.5 percent. A maturity risk premium is estimated to be 0.2 percentage points for the longer maturity bond. Investors expect inflation to average 1.5 percentage points over the next 10 years. Estimate the expected real rate of return on the 10-year U.S. Treasury note.

Answer 1

Answer:

1.0 percent

Explanation:

Expected real rate of return can be described as the proportion of the annual return or profit from an investment after deducting inflation.

The purpose of the real rate of return is to show the accurate and actual purchasing power of a certain sum of money over a period of time.

An investor can therefore know what is the real return of a nominal return when the nominal interest is adjusted for inflation.

From the question, we have:

Interest rate on 10-year Treasury note = 2.5 percent

Expected Inflation = 1.5 percent

Therefore, the expected real rate of return on the 10-year Treasury note is derived by subtracting the 1.5 percent expected Inflation from the 2.5 percent interest rate on 10-year Treasury note as follows:

Expected real rate of return on the 10-year Treasury note = 2.5 - 1.5

                                                                                                = 1.0 percent

Therefore, the expected real rate of return on the 10-year U.S. Treasury note is 1.0 percent.

All the best.