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OU An investor in Treasury securities expects inflation to be 2.0% In Year 1, 2.5% in Year 2, and 3.65% each year thereafter.
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Answer #1

Solution :-

Inflation Premium of

3 years :- (2% + 2.5% + 3.65% ) / 3 = 2.717%

5 years = (2% + 2.5% + 3.65% + 3.65% + 3.65%) / 5 = 3.09%

Now

Yield rate = Real risk free rate + inflation premium + market risk premium.

3 years :-

6.30% = 2.15% + 2.717% + Market risk premium (3yr)

Market risk premium (3yr) = 1.433%

5 years :-

8.00% = 2.15% + 3.09% + Market risk premium (5yr)

Market risk premium (5yr) = 2.76%

Now

MPR5 - MRP3 = 2.76% - 1.433% = 1.33%

If there is any doubt please ask in comments

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