The real rate of interest is expected to be 3%, and the expected rate of inflation for next year is expected to be 5.5%. If the default risk premium is 1.1 percentage points, and the seniority risk premium is 0.4 percentage points, what is the required return on a 1-year U.S. Treasury security?
A) 9.6%
B) 10.0%
C) 8.5%
D) 8.9%

Question

Quizplus · Accepted Answer

The required return on a 1-year U.S. Treasury security is calculated by adding the real rate of interest and the expected rate of inflation, as U.S. Treasury securities are considered risk-free and do not include default or seniority risk premiums. Therefore, 3% (real rate) + 5.5% (inflation) = 8.5%.

The Real Rate of Interest Is Expected to Be 3