14. The real risk-free rate of interest is 2%. Inflation is expected to be 3.5% the next 2 years and 6% during the next 3 years after that. Assume that the maturity risk premium is zero. What is the yield on 3-year Treasury securities? What is the yield on 5-year Treasury securities?

3-year = 6.33%

5-year = 7%

Explanation:

Yield in security = Risk free rate + Maturity risk premium + Inflation premium + Liquidity premium + Default risk premium

Maturity risk premium is given as 0

Yield on 3-year treasury securities is 2 + [ (3.5 + 3.5 + 6) / 3] + 0

= 6.33%

Yield on 5-year treasury securities is 2 + [ (3.5 + 3.5 + 6 + 6 + 6) / 5] + 0

=7%