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Economics
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Assuming the same risk structure and term to the maturity of the investments, if the yield on a Treasury Inflation Protected Security (TIPS) is 0.28 percent, and the yield on a regular Treasury Bond is 2.73 percent, then:

A. Write down and explain parts of equation for a nominal rate of interest

B. Calculate the expected rate of inflation

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4 Jan 2018
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Related questions

Suppose the inflation rate is expected to be 6.6% next year, 4.6% the following year, and 3.05% thereafter. Assume that the real risk-free rate, r*, will remain at 2.45% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a few days) to 0.2% for 1-year securities. Furthermore, maturity risk premiums increase 0.2% for each year to maturity, up to a limit of 1.0% on 5-year or longer-term T-bonds.

a. Calculate the interest rate on 1-year Treasury securities. Round your answer to two decimal places.

b. Calculate the interest rate on 2-year Treasury securities. Round your answer to two decimal places.

c. Calculate the interest rate on 3-year Treasury securities. Round your answer to two decimal places.

d. Calculate the interest rate on 4-year Treasury securities. Round your answer to two decimal places.

e. Calculate the interest rate on 5-year Treasury securities. Round your answer to two decimal places.

f. Calculate the interest rate on 10-year Treasury securities. Round your answer to two decimal places.

g. Calculate the interest rate on 20-year Treasury securities. Round your answer to two decimal places.

Suppose I borrow $200,000 for one year at a fixed nominal interest rate of 7 percent.

(a) What is my nominal repayment next year?

(b) Suppose that at the time the loan was made, both the lender and I believed that the (ex-ante) rel interest rate on the loan would be two percent. Suppose the actual inflation rate over the life of the loan turns out to be 4 percent. What is the ex-post real interest rate? Does the inflation rate help me at the expense of the lender, or help the lender at my expense?

(c) Re-do question (b) assuming that the inflation rate turns out to be 5 percent and 6 percent.

(d) Given that the lender and I agreed that the ex-ante real interest rate should be 2 percent, what nominal interest rate would I have been charged if the lender and I had expected inflation over the life of the loan to be 10 percent? 3 percent? 0 percent?

(e) Inflation increased enexpectedly during the 1970s. Explain why this helped someone who bought a house using a 30-year mortgage with fixed nominal interest rates in 1965, but not someone who bought a house using a 30-year mortgage with a fixed nominal interest rate in 1980.

5. Current annualized yields on 1 year US treasury securities are only .28%....while current annualized yields on 2 year US treasury securities are .69% (note you may assume that both 1 and 2 year securities in this example are “0” coupon securities with no payment other than the maturity value on the maturity date.

What does this data suggest about financial market expectations of 1 year yields, 1 year from now? Explain…. (Assume investors are risk neutral in these short time horizons with default free treasuries.)

6. Here’s a quote from Fed head Janet Yellen on at a meeting in Cleveland on July 10 this year. (see www.federalreserve.gov then click news and events…

Regarding inflation, as I mentioned earlier, the recent effects of lower prices for crude oil and for imports on overall inflation are expected to wane during this year. Combined with further tightening in labor and product markets, I expect inflation will move toward the FOMC's 2 percent objective over the next few years. Importantly, a number of different surveys indicate that longer-term inflation expectations have remained stable even as recent readings on inflation have fallen. If inflation expectations had not remained stable, I would be more concerned because consumer and business expectations about inflation can become self-fulfilling.

Explain why the FOMC is concerned not only about actual recent inflation rates as measured by the CPI, but also about longer term inflation expectations remaining “stable” In particular, what is the problem if inflation expectations start to converge to an opinion that inflation will fall to “0” or less?

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