Assume that the real risk-free rate, r*, is 3% and that inflation is expected to be 7% in Year 1, 5% in Year 2, and 3% thereafter. Assume also that all Treasury securities are highly liquid and free of default risk. If 2-year and 5-year Treasury note both yield 10%, what is the difference in the maturity risk premiums (MRPs) on the two notes; that is, what is MRP5 minus MRP2?
Treasury bonds are bonds issued by the government, which have the least default risk compared to corporate bonds. In a financial analysis, analysts will consider T-bond's yield is a risk-free rate.
Answer and Explanation: 1
Approximation formula for nominal rate of return:
Nominal rate of return = Real risk-free rate + Inflation risk premium + Maturity risk premium
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fromChapter 6 / Lesson 7
Learn the definition of treasury bonds, understand their advantages and disadvantages, and explore U.S. treasury bond examples.