Share
Explore BrainMass

Interest Rates

Due to a recession, the inflation rate expected for the coming year is only 3 perecent. However, the inflation rate in Year 2 and thereafter is expected to be constant t some level above 3%. Assume that the real risk-free rate is k*= 2% for all maturities and that the expectations theory explains the yield curve,so there are no maturity risk premiums. If 3-year Treasury bonds yield 2 percentage points more than 1-year bonds, what inflation rate is expected after Year 1?

Solution Preview

Of the 1-year bond, the nominal rate = real risk-free rate + expected inflation ...

$2.19