Question

(Expected Interest Rate) The real risk-free rate is 2.25%. Inflation is expected to be 2.50% this year and 4.00% during the next 2 years. Assume that the maturity risk premium is zera. What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places. What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

The yield on a 2-year Treasury security is 8.75%, while the yield on a 3-year Treasury security is 12.75%.

Step-by-step explanation:

The yield on a 2-year Treasury security is calculated by adding the expected inflation rate to the real risk-free rate. In this case, the expected inflation rate is 2.50% this year and 4.00% over the next 2 years, and the real risk-free rate is 2.25%. Therefore, the yield on a 2-year Treasury security would be 2.25% + 2.50% + 4.00% = 8.75%.

The yield on a 3-year Treasury security is calculated in a similar way. Adding the expected inflation rate for the next 3 years (2.50% + 4.00% + 4.00% = 10.50%) to the real risk-free rate of 2.25% gives a yield on a 3-year Treasury security of 12.75%.