Assume that it is now 3rd January, 2010. The rate of inflation is expected to be 6 percent throughout 2010. However, increased government deficits and renewed vigor in the economy are then expected to push inflation rates higher. Investors expect the inflation rate to be 7 percent in 2011, 8 percent in 2012, 9 percent in 2013 and 11 percent in 2014. The real risk-free rate, k*, is expected to remain at 4 percent over the next 6 years. Assume that no maturity risk premiums are required on bonds with 5 years or less to maturity. The current interest rate on 6-year T-bonds is 12 percent. Required: What is the average expected inflation rate over the next 5 years? What should be the prevailing interest rate on 5-year T-bonds? What is the implied expected inflation rate in 2015, or Year 6, given that Treasury bonds which mature in that year yield 12 percent?
Assume that it is now 3rd January, 2010. The rate of inflation is expected to be 6 percent throughout 2010. However, increased government deficits and renewed vigor in the economy are then expected to push inflation rates higher. Investors expect the inflation rate to be 7 percent in 2011, 8 percent in 2012, 9 percent in 2013 and 11 percent in 2014. The real risk-free rate, k*, is expected to remain at 4 percent over the next 6 years. Assume that no maturity risk premiums are required on bonds with 5 years or less to maturity. The current interest rate on 6-year T-bonds is 12 percent. Required: What is the average expected inflation rate over the next 5 years? What should be the prevailing interest rate on 5-year T-bonds? What is the implied expected inflation rate in 2015, or Year 6, given that Treasury bonds which mature in that year yield 12 percent?
Chapter8: Analysis Of Risk And Return
Section: Chapter Questions
Problem 10P
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Assume that it is now 3rd January, 2010. The rate of inflation is expected to be 6 percent throughout 2010. However, increased government deficits and renewed vigor in the economy are then expected to push inflation rates higher. Investors expect the inflation rate to be 7 percent in 2011, 8 percent in 2012, 9 percent in 2013 and 11 percent in 2014. The real risk-free rate, k*, is expected to remain at 4 percent over the next 6 years. Assume that no maturity risk premiums are required on bonds with 5 years or less to maturity. The current interest rate on 6-year T-bonds is 12 percent.
Required:
- What is the average expected inflation rate over the next 5 years?
- What should be the prevailing interest rate on 5-year T-bonds?
- What is the implied expected inflation rate in 2015, or Year 6, given that Treasury bonds which mature in that year yield 12 percent?
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