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.

a. 2.5%b. 1.0%c. 3.5%d. 5.5%

Answer 1

b. 1.0%

Step-by-step explanation:

The real rate of return will be difference between the nominal rate and the inflation expected for the period.

`r_(nominal) - \delta = r_(real)`

The Treasury Note will yield 2.5% but;

There is inflation for 1.5% thus;

Real Rate: 2.50% - 1.50% = 1.00%

The maturity risk is a return added to the rate but, is used in the calculation of the treasury note nominal rate so it is not relevant for this calculation.