If the yield to maturity for a par value TIPS bond with 8 years to maturity is 3%,and the yield to maturity of a U.S Treasury note with 8 years is 4.25%,this implies that
A) The expected annual rate of inflation over the next 8 years is -1.25%.
B) The expected annual rate of inflation over the next 8 years is 1.25%.
C) The expected annual rate of inflation over the next 8 years is -2.25%
D) The expected annual rate of inflation over the next 8 years is 2.25%
E) None of the above.

Question

Quizplus · Accepted Answer

The yield on a TIPS bond incorporates an inflation component, while the yield on a Treasury note does not. Therefore, the difference in yields between the two can be used to calculate an expected inflation rate. The difference between the two yields is 4.25% - 3% = 1.25%. This implies that the market expects an average inflation rate of 1.25% per year over the next 8 years. Therefore, option B is the correct answer.

If the Yield to Maturity for a Par Value TIPS