Suppose the real risk-free rate is at 4.20%, the average expected future inflation rate is 2.50%,...

Question:

Suppose the real risk-free rate is at 4.20%, the average expected future inflation rate is 2.50%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 6.96%

b. 7.67%

c. 7.10%

d. 5.40%

e. 7.53%

Treasury Securities:

Treasury securities are government bonds which are issued by american government. The treasury with short term maturity period is called treasury bill and the long term treasury is called treasury notes.

Answer and Explanation:

r = required return on a debt security

{eq}r^{.} {/eq} = real risk-free rate of interest

IP = Inflation premium

DRP = default risk premium

LP =...

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Government Securities: Definition, Types & Examples

from Introduction to Business: Homework Help Resource

Chapter 24 / Lesson 12
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