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The real risk-free rate is 3.25%, and inflation is expected to be 2% for the next 2 years. A 2-year Treasury security yields 8%. What is the maturity risk premium for the 2-year security? Round your answer to two decimal places.

Solution

Yield on a Treasury security = Real risk free rate + Inflation premium + Maturity risk premium

Inflation Premium over two years is average inflation = (2% + 2%)/2 = 2%

Real risk free rate = 3.25%

Yield on a Treasury security = 8%

Therefore, Maturity risk premium = 8% - 3.25% - 2% = 2.75%