The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4% during the next 2 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?

The yield on a 2-year treasury securities is 6.00%

While the yield on 3-year treasury securities is 6.33%

Explanation:

Real-risk free rate = 3%

Inflation is expected to be 2% this year and 4% during the next 2 years

Also noting that maturity risk premium is zero

As a result, the yield on 2-year treasury securities is computed:

r = r * + IP + MRP

r*=real-risk free rate=3%

IP=average of this year inflation and that of two years' time

MRP=market risk premium=0

r = 3% + (2% + 4%) / 2 + 0

r = 6%

The yield of 3-year treasury securities is given thus:

r = r * + IP + MRP

r = 3% + (2% + 4% + 4%) / 3 + 0

Note that the IP is now taking into consideration average of the three inflation figures given.

r = 6.33%