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Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 2.50%, and a maturity risk premi...

Suppose the real risk-free rate is 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. What rate of return would you expect on a 4 year Treasury Security?

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Answer #1

For a Treasury Security,

Nominal Yield = Real risk free rate + Inflation premium + Maturity risk premium

Maturity risk premium for a 4 yr bond = 0.10%* 4 = 0.40%

Nominal Yield for bond = 4.20% + 2.50% + 0.40%

Nominal yield = 7.10%

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