Question

The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 7.25 percent. From discussions with your broker, you have determined that the expected inflation premium will be 1.75 percent next year, 2.25 percent in year 2, and 2.40 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.75 percent annually for the foreseeable future. What is the maturity risk premium on the six-year Treasury security? 1.10 percent 0.983 percent 1.233 percent 0.83 percent

Answer 1

The maturity risk premium for the security is 1.10%

Explanation:

Consider the provided information.

We need to determine the maturity risk premium on the six-year Treasury security.

It is given that Treasury rate is 7.25 percent for the six-year.

The expected inflation premium will be 2.40 percent in year 3 and beyond.

You expect that real interest rates will be 3.75 percent annually for the foreseeable future.

As we know the nominal interest rates is:

`i^*_j=f(IP,RIR,DRP_j,LRP_j,SCP_j,MP_j)`

We have given

Nominal interest rate of security = 7.25

IP: Inflation premium of security = 2.40

RIP: Real interest rate of security = 3.75

We need to find MP (Maturity premium of security).

Substituting the respective values we get:

`7.25\%=2.40\%+3.75\%+MP`

`7.25\%=6.15\%+MP`

`1.10\%=MP`

Hence, the maturity risk premium for the security is 1.10%