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Assume that the real risk-free rate is 2% and that the maturity risk premium is zero.

If a 1-year Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for year 2? Calculate this yield using a geometric average.

What inflation rate is expected during year 2?

Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for year 2.

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Joshua Stredder
Joshua StredderLv10
17 Jan 2021

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Assume that the real risk-free rate is 2% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2? What inflation rate is expected during year 2? Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2.

Suppose the annual yield on a 2-year Treasury bond is 6 percent, the yield on a 1-year bond is 5 percent, the real risk-free rate is 3 percent, and the maturity risk premium is 0.

a) Using the expectations theory, forecast the interest rate on a 1-year bond during the second year. (Hint: Under the expectations theory, the yield on a 2-year bond is equal to the average yield on 1-year bonds in Year 1and Year 2)

b) What is the expected inflation rate in Year 1? Year 2?

Suppose the annual yield on a 2-year Treasury bond is 6 percent, the yield on a 1-year bond is 5 percent, the real risk-free rate is 3 percent, and the maturity risk premium is 0.

  1. Using the expectations theory, forecast the interest rate on a 1-year bond during the second year. (Hint: Under the expectations theory, the yield on a 2-year bond is equal to the average yield on 1-year bonds in Year 1and Year 2.)

What is the expected inflation rate in Year 1? Year 2?

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