Question

Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 1.80%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, 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. a. 2.66% b. 1.88% c. 2.35% d. 2.00% e. 2.49%

Answer 1

Answer:

c. 2.35%

Explanation:

10 year T bond Yield = 5.05 % (let it be rT10)

10 year TIPS yield = 1.8 % ( let it be r* )

MRP = 0.9%

Expected Inflation = rT10 - r* - MRP

                               = 5.05 % - 1.8 % - 0.9%

                               = 2.35 %

Therefore, The expected rate of inflation over the next 10 years is 2,35%.