Question

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.80%. what rate of return would you expect on a 1-year treasury security, assuming the pure expectations theory is valid? disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. group of answer choices

O 8.38%
O 9.79%
O 8.80%
O 8.30%

Answer 1

To calculate the expected rate of return on a 1-year Treasury security, add the real risk-free rate (3.50%) to the expected rate of inflation (4.80%), resulting in an expected rate of 8.30%.

Correct answer is last option 8.30%

Step-by-step explanation:

The question seeks to determine the expected rate of return on a 1-year Treasury security based on the real risk-free rate and the expected rate of inflation, using the pure expectations theory. The formula to determine the expected nominal interest rate (the rate of return you would expect on a Treasury security) combines the real risk-free rate and the expected inflation rate.

To find the expected rate of return, we simply add the real risk-free rate to the expected inflation rate:
3.50% (real risk-free rate) + 4.80% (expected inflation rate) = 8.30% (expected rate of return)

Therefore, based on the given data, the correct option for the rate of return you would expect on a 1-year Treasury security is 8.30% percent.