Question

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 2.60%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Answer 1

5.70%

Step-by-step explanation:

Given that

Real risk free rate = 3%

Expected future inflation rate = 2.60%

Maturity risk premium = 0.10%

So, by considering the above information , the rate of return expected would be

= Real risk free rate + Expected future inflation rate + Maturity risk premium

= 3% + 2.60% + 0.10%

= 5.70%

We simply added the above three items so that the expected return could come