If you expect the inflation premium to be 2%, the default risk premium to be 1% and the real interest rate to be 4%, what interest would you expect to observe in the marketplace on short term treasury securities?
A) 8%
B) 7%
C) 6%
D) 5%

Question

Quizplus · Accepted Answer

The interest rate observed in the marketplace can be calculated by adding the real interest rate, the inflation premium, and the default risk premium together: 4% (real interest rate) + 2% (inflation premium) + 1% (default risk premium) = 7%. However, since Treasury securities are considered default-risk-free, the default risk premium is not applicable in this case, making the correct calculation: 4% (real interest rate) + 2% (inflation premium) = 6%.

If You Expect the Inflation Premium to Be 2%, the Default