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).
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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from Introduction to Business: Homework Help ResourceChapter 24 / Lesson 12