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Expectations theory

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Expectations theory: what should be the interest rate on 3-year, risk-free securities?

The real risk-free rate of interest is 3 percent. Inflation is expected to be 2 percent this year, and 4 percent during the next two years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury Securities? What is the yield on 3-year Treasury securities?

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Solution Summary

Expectations theory is applied to find the interest rate on 3-year, risk-free securities.

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The first thing you need to do in thee problems is to find the average inflation rate for the period you are interested in, i,.e 2 ...

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