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    annual inflation

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    As a result of a recession consumer expectations of annual inflation declined from 2% to 1.5% and, at the same time, the expected real rate of return required to equate investor demand to the existing supply of default risk- free Treasury bonds declined from 3% to 1%.

    Draw a supply/demand diagram of the US Treasury bond market to illustrate the effects on it of the developments based on the situation above. (example S/D diagram is attached)

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    Solution Preview

    Nominal Yield - the formula between Nominal Yield (Rn), real rate of return (Rr) and inflation (i):
    Rn = (1+Rr)*(1+i) -1

    Thus we know the nominal yields on US Treasury ...

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