Question

The real risk-free rate is 2.15%. Inflation is expected to be

3.15% this year, 4.55% next year, and 2.3% thereafter. The maturity
risk premium is estimated to be 0.05 × (t - 1)%, where t = number
of

Answer 1

The question centers around calculating inflation rates using percentage change in price index and incorporating the real risk-free rate and maturity risk premium in financial analysis.

Step-by-step explanation:

The subject of the question involves understanding how to calculate the expected inflation rates and apply them to determine the overall return on an investment, considering the real risk-free rate and the maturity risk premium. The inflation rate is calculated using the percentage change in the price index from one year to the next, which plays a significant role in financial calculations and economic analysis.

For instance, using the provided example, the inflation rate between two periods is calculated as follows: (Price Index in Year 2 - Price Index in Year 1) / Price Index in Year 1. If the price index changed from 69.71 to 84.61, the inflation rate is calculated as (84.61 – 69.71) / 69.71 = 0.2137 or 21.37%. The calculation of the maturity risk premium introduces an additional factor to consider for longer-term investments, which accounts for the added risk associated with time.