Suppose the rate of return on a 10 year T-bond is currently 5.00% and that on a 10- year Treasury Protected Security (TIP) is 2.10%. Suppose further that the MRP on a 10 year T-bond is 0.9% that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
k = k* + IP + DRP + LP + MRP.
K T-10 = 5% = k* + IP + MRP; (DRP = LP = 0.)
SOLUTION PREVIEW
K T-10 = 5%; MRP =
0.9%; LP = 0
k = k* + IP + DRP + LP + MRP.
K T-10 = 5% = k* + IP + MRP; (DRP = LP = 0.)
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