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If the 10-year Treasury bond rate is 4.9%, the inflation premium is 2.1%, and the maturity-risk...

Question:

If the {eq}10 {/eq}-year Treasury bond rate is {eq}4.9 \% {/eq}, the inflation premium is {eq}2.1 \% {/eq}, and the maturity-risk premium on {eq}10 {/eq}-year Treasury bonds is {eq}0.3 \% {/eq}, assuming that there is no liquidity-risk premium on these bonds, what is the real risk-free interest rate?

Risk-free Rate:

Risk-free rate is the return on a risk-free investment. In practice, short-term government bonds are usually considered risk-free assets, and thus the return on these bonds are often used a proxy for the risk-free rate.

Answer and Explanation:

The real risk free rate is 2.4%.

We can use the following formula for treasury bond yield to answer the question:

  • bond yield =real risk free rate + inflation premium + maturity risk premium + liquidity premium
  • 4.9% = real risk free rate + 2.1% + 0.3% + 0
  • 4.9% = 2.5% + real risk free rate
  • real risk free rate = 2.4%

Learn more about this topic:

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How to Calculate Risk Premium: Definition & Formula

from Financial Accounting: Help and Review

Chapter 5 / Lesson 26
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