Assume the real rate of interest on 1-year, 10-year, and 30-year bonds is 3%. Also assume the rate of inflation is expected to be 3% for the coming year. Considering only an inflation premium, construct an example showing how an expected increase in the rate of inflation leads to an upward sloping term structure via the Fisher effect. Then, explain how the addition of interest rate risk will affect your results.

Question

Quizplus · Accepted Answer

The Answer of Assume the real rate of interest on 1-year, 10-year, and 30-year bonds is 3%. Also assume the rate of inflation is expected to be 3% for the coming year. Considering only an inflation premium, construct an example showing how an expected increase in the rate of inflation leads to an upward sloping term structure via the Fisher effect. Then, explain how the addition of interest rate risk will affect your results.

Assume the Real Rate of Interest on 1-Year, 10-Year, and 30-Year