Question

The real risk-free rate is 3.55%, inflation is expected to be 3.60% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

Answer 1

7.15%

Step-by-step explanation:

The formula to compute the equilibrium rate of return is shown below:

Expected rate of return = Risk-free rate of return + expected inflation rate + (Market rate of return - Risk-free rate of return)

= 3.55% + 3.60% + 0

= 7.15%

The (Market rate of return - Risk-free rate of return) is also known as market risk premium and the same is applied.