1. Suppose you and most other investors expect the inflation rate to be 3.00% next year, 4.00% during the following year, and then to remain at a rate of 5.00% thereafter. Assume that the real risk-free rate will remain at 1.00% and that maturity risk premiums on Treasury securities rise from zero on very short- term securities to a level of 0.10% percentage points for 1-year securities. Furthermore, maturity risk premiums increase 0.10 percentage points for each year to maturity, up to a limit of 1.00 percentage point on 10-year or longer-term T-notes and T-bonds.

Calculate the interest rate on a 5-year Treasury securities.

5.70%

6.30%

5.90%

6.10%

2. The real risk-free rate is 0.90%. Inflation is expected to be 1.00% this year, 2.00% next year, and 3.00% thereafter. The maturity risk premium is estimated to be 0.01 × (t – 1)%, where t = number of years to maturity. What is the nominal interest rate on a 9-year Treasury security?

3.567%

6.980%

3.647%

2.980%