Question

Assume that the real, risk-free rate of interest is expected to be constant. over time at 3.0 percent, and that the annual yield on 4 -year Treasury securities is 7.15 percent, while the annual yield on 6-year Treasury securities is 7.75 percent: you may assume that the default risk and liquidity premium on Treasury securities is zero. Also assume that the maturity risk premium for all securities can be estimated as MRP = (0.15%) ∗

(t−1), where t is the number of periods until maturity. Given this information, and assuming that the expected rate of inflation for Year 1 is 3.0 percent, for Year 2 is 3.5%, for Year 3 is 4.0 percent (you should now be able to determine what the expected rate is for Year 4), and that the expected rate of inflation for Year 6 is 4.50 percent, determine what the narket must anticipate the rate of inflation will be in Year 5. 4.30% 4.70% 3.0 percent, for Year 2 is 3.5%, for Year 3 is 4.0 percent (you should now be able to determine what the expected rate is for Year 4), and that the expected rate of inflation for Year 6 is 4.50 percent, determine what the market must anticipate the rate of inflation will be in Year 5. 4.30% 4.70% 3.90% 4.50% 4.10%

Answer 1

The market must anticipate the rate of inflation to be 0.15% in Year 5.

Step-by-step explanation:

To determine the anticipated rate of inflation for Year 5, we need to consider the given information and the formula for the maturity risk premium. The real, risk-free rate of interest is 3.0 percent, and the annual yield on 4-year Treasury securities is 7.15 percent. Using the formula for the maturity risk premium, we can calculate the maturity risk premium for 4-year Treasury securities:

MRP = (0.15%) * (4-1) = 0.45%

Adding the maturity risk premium to the annual yield on 4-year Treasury securities, we get:

7.15% + 0.45% = 7.60%

Similarly, the annual yield on 6-year Treasury securities is 7.75 percent. Calculating the maturity risk premium for 6-year Treasury securities:

MRP = (0.15%) * (6-1) = 0.75%

Adding the maturity risk premium to the annual yield on 6-year Treasury securities, we get:

7.75% + 0.75% = 8.50%

Now, we can use the expected rate of inflation for previous years to determine the anticipated rate of inflation for Year 5. The expected rate of inflation for Year 1 is 3.0 percent, for Year 2 is 3.5 percent, and for Year 3 is 4.0 percent. We can calculate the anticipated rate of inflation for Year 4 using the formula for the maturity risk premium:

MRP = (0.15%) * (4-1) = 0.45%

Adding the maturity risk premium to the expected rate of inflation for Year 3, we get:

4.0% + 0.45% = 4.45%

Finally, to determine the anticipated rate of inflation for Year 5, we can use the expected rate of inflation for Year 4 and the formula for the maturity risk premium:

MRP = (0.15%) * (5-1) = 0.60%

Adding the maturity risk premium to the expected rate of inflation for Year 4, we get:

4.45% + 0.60% = 5.05%

Therefore, the market must anticipate the rate of inflation to be 5.05% in Year 5.