Question

Assume that a 3-year Treasury security yields 3.70%. Also assume that the real risk-free rate (r*) is 0.75%, and Inflation is expected to be 2.25% annually for the next 3 years. In addition to inflation, the nominal interest rate also includes a maturity risk premium (MRP) that reflects interest rate risk. What is the maturity risk premium for the 3-year security? Your answer should be between 0.00 and 2.92, rounded to 2 decimal places, with no special characters.

Answer 1

The maturity risk premium for the 3-year Treasury security is 0.70%, calculated by subtracting the sum of the real risk-free rate and expected inflation rate from the nominal interest rate.

Step-by-step explanation:

The maturity risk premium (MRP) for the 3-year Treasury security can be determined by separating the components of the nominal interest rate. We know the nominal interest rate (3.70%), the real risk-free rate (r*) (0.75%), and the expected inflation rate (2.25%). The nominal interest rate is the sum of these figures plus the MRP. To calculate MRP, we use the following formula:

Nominal Interest Rate = r* + Inflation Premium + MRP

We rearrange this to solve for MRP:

MRP = Nominal Interest Rate - (r* + Inflation Premium)

Therefore:

MRP = 3.70% - (0.75% + 2.25%) = 0.70%

The maturity risk premium for the 3-year security is 0.70%.