The real riskfree rate is 3 Inflation is expected to be 15 t

The real risk-free rate is 3%. Inflation is expected to be 1.5% this year and 3.5% during the next 2 years. Assume that the maturity risk premium is zero.

What is the yield on 2-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.

%

What is the yield on 3-year Treasury securities? Do not round intermediate calculations. Round your answer to two decimal places.

%

Solution

Maturity risk premium is zero in this case. This means,

Nominal Yield = Real risk free rate + Inflation premium

a) For a 2 year Treasury security

Nominal yield = Real risk free rate + Average of inflation over two years

Nominal Yield = 3% + (1.5% + 3.5%)/2 = 3% + 2.5% = 5.5%

b) For a 3 year Treasury security

Nominal yield = Real risk free rate + Average of inflation over three years

Nominal Yield = 3% + (1.5% + 3.5% + 3.5%)/3 = 3% + 2.83% = 5.83%