Question

The real risk-free rate is 3.55%, inflation is expected to be 3.60% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond? (Round your final answer to 3 decimal places.) a. 8.224% b. 7.059% c. 6.914% d. 7.278% e. 8.442%

Answer 1

Answer:

d. 7.278%

Explanation:

Real risk-free rate of return = ((1 + Nominal/ Equilibrium rate of return) /(1 + Inflation rate)) - 1

From this formula we get:

Equilibrium rate of return = ((1 + Real risk-free rate) * (1 + Inflation rate)) -1

                                          = ((1 + 3.55%) * (1 + 3.60%)) - 1

                                          = 7.278%

Therefore, The equilibrium rate of return is 7.278%.