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Suppose the rate of return on a 10-year T-bond is 6.85%, the expected average rate of inflation...

Question:

Suppose the rate of return on a 10-year T-bond is 6.85%, the expected average rate of inflation over the next 10 years is 2.0%, the MRP on a 10-year T-bond is 0.9%, no MRP is required on a TIPS, and no liquidity premium is required on any Treasury security. Given this information, what should the yield be on a 10-year TIPS? (Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average).

a). 4.86%

b). 3.95%

c). 4.38%

d). 4.58%

e). 4.62%

TIPS Return:

Treasury inflation protected securities (TIPS) are designed so that they are immune to inflation. As a result, they do not provide any return to compensate for inflation. This means that at times the return of TIPS can be negative.

Answer and Explanation:

TIPS are securities designed to be immune from inflation and other risks. The return they provide is real return. Thus,

  • TIPS return = T-bond return...

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Government Securities: Definition, Types & Examples

from Introduction to Business: Homework Help Resource

Chapter 24 / Lesson 12
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