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5 January, 17:18

The real risk-free rate of interest is 2%. Inflation is expected to be 3% the next 2 years and 5% during the next 3 years after that. Assume that the maturity risk premium is zero. What is the yield on 3-year Treasury securities?

a. 5.2%

b. 6.2%

c. 5.7%

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  1. 5 January, 17:46
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    c. 5.7%

    Explanation:

    The computation of the yield on 3-year Treasury securities is shown below:

    = Real Risk - free rate of return + Inflation premium + maturity risk premium

    where,

    Real Risk - free rate of return = 2%

    Inflation premium = (3% + 3% + 5%) : 3 = 3.67%

    And, the maturity risk premium = 0%

    So, the yield on 3-year Treasury securities is

    = 2% + 3.67% + 0%

    = 5.67%
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