Suppose you and most other investors expect the inflation rate to be 7%next year, to fall to 5% during the following year, and then to remain ata rate of 3% thereafter. Assume that the real risk-free rate, r*, will remainat 2% and that maturity risk premiums on Treasury securities rise fromzero on very short-term securities (those that mature in a few days) to alevel of 0.2 percentage points for 1-year securities. Furthermore, maturityrisk premiums increase 0.2 percentage points for each year to maturity, upto a limit of 1.0 percentage point on 5-year or longer-term T-notes andT-bonds.a. Calculate the interest rate on 1-, 2-, 3-, 4-, 5-, 10-, and 20-year Treasurysecurities, and plot the yield curve.
Suppose you and most other investors expect the inflation rate to be 7%
next year, to fall to 5% during the following year, and then to remain at
a rate of 3% thereafter. Assume that the real risk-free rate, r*, will remain
at 2% and that maturity risk premiums on Treasury securities rise from
zero on very short-term securities (those that mature in a few days) to a
level of 0.2 percentage points for 1-year securities. Furthermore, maturity
risk premiums increase 0.2 percentage points for each year to maturity, up
to a limit of 1.0 percentage point on 5-year or longer-term T-notes and
T-bonds.
a. Calculate the interest rate on 1-, 2-, 3-, 4-, 5-, 10-, and 20-year Treasury
securities, and plot the yield curve.
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