Assume that the real risk-free rate is 2.4% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5.6% and a 2-year Treasury bond yields 6.3%. Calculate the yield using a geometric average. What is the 1-year interest rate that is expected for Year 2? Do not round intermediate calculations. Round your answer to two decimal places. % What inflation rate is expected during Year 2? Do not round intermediate calculations. Round your answer to two decimal places. % Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2. The difference is due to the inflation rate reflected in the two interest rates. The inflation rate reflected in the interest rate on any security is the average rate of inflation expected over the security's life. The difference is due to the real risk-free rate reflected in the two interest rates. The real risk-free rate reflected in the interest rate on any security is the average real risk-free rate expected over the security's life. The difference is due to the fact that the maturity risk premium is zero. The difference is due to the fact that we are dealing with very short-term bonds. For longer term bonds, you would not expect an interest rate differential. The difference is due to the fact that there is no liquidity risk premium. -Select-IIIIIIIVVItem 3

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Assume that the real risk-free rate is 2.4% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5.6% and a 2-year Treasury bond yields 6.3%. Calculate the yield using a geometric average.

What is the 1-year interest rate that is expected for Year 2? Do not round intermediate calculations. Round your answer to two decimal places.

What inflation rate is expected during Year 2? Do not round intermediate calculations. Round your answer to two decimal places.

Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2.

The difference is due to the inflation rate reflected in the two interest rates. The inflation rate reflected in the interest rate on any security is the average rate of inflation expected over the security's life.
The difference is due to the real risk-free rate reflected in the two interest rates. The real risk-free rate reflected in the interest rate on any security is the average real risk-free rate expected over the security's life.
The difference is due to the fact that the maturity risk premium is zero.
The difference is due to the fact that we are dealing with very short-term bonds. For longer term bonds, you would not expect an interest rate differential.
The difference is due to the fact that there is no liquidity risk premium.

-Select-IIIIIIIVVItem 3

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