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You've just taken a job at a investment-banking firm and been given the job of calculating the appropriate nominal interest rate for a number of...
You’ve just taken a job at a investment-banking firm
and been given the job of calculating the appropriate nominal interest rate for a number
of different Treasury bonds with different maturity dates. The real risk-free interest
rate that you have been told to use is 2.5%, and this rate is expected to continue
on into the future without any change. Inflation is expected to be constant over the
future at a rate of 2.0%. Since these are bonds that are issued by the U.S. Treasury,
they do not have any default risk or any liquidity risk (that is, there is no liquidityrisk
premium). The maturity-risk premium is dependent upon how many years the
bond has to maturity. The maturity-risk premiums are as follows:
BOND MATURES IN: MATURITY-RISK PREMIUM:0–1 year 0.05%1–2 years 0.30%2–3 years 0.60%3–4 years 0.90%
Given this information, what should the nominal rate of interest on Treasury bondsmaturing in 0–1 year, 1–2 years, 2–3 years, and 3–4 years be?
