problem1: Assume the rate of return on a ten year T-bond is 5.00percent and that on a ten year Treasury Inflation Protected Security (TIP) is 2.10percent. Suppose further that the expected average rate of inflation over the next 10 years is 2.0percent, that the MRP on a ten year T-bond is 0.9percent, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, determine the real risk free rate of return, r*? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
problem2. The real risk-free rate is three percent, inflation is expected to be two percent this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a one year Treasury bond?