Question

Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 7.00%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 9.50% b. 11.59% c. 7.70% d. 7.41% e. 8.46%

Answer 1

Answer:

option (a) 9.50%

Step-by-step explanation:

Data provided in the question:

The real risk free rate = 2.50%

The future rate of inflation = 7.00%

Now,

The Expected rate of return after 5 - year treasury deposited will be calculated using the relation,

Return rate = Inflation rate + Real risk free rate

on substituting the respective values, we get

Return rate = 7.00% + 2.50%

or

Return rate = 9.50%

Hence,.

the correct answer is option (a) 9.50%

Answer 2

The rate of return would you expect on a 5-year Treasury security is 9.50%.

Rate of return

Using this formula

Rate of return =Risk-free rate + Expected future rate of inflation

Where:

Risk-free rate=2.50%

Expected future rate of inflation=7.00%

Let plug in the formula

Rate of return=2.50%+ 7.00%

Rate of return= 9.50%

Inconclusion The rate of return would you expect on a 5-year Treasury security is 9.50%.

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