Interest rates The Wall Street Journal reports that the rate on 3-year Treasury securities is 7.00 percent, and the 6-year Treasury rate is 7.25 percent. From discussions with your broker, you have determined that expected inflation premium is 1.75 percent next year, 2.25 percent in Year 2, and 2.40 percent in Year 3 and beyond. Further, you expect that real interest rates will be 3.75 percent annually for the foreseeable future. What is the maturity risk premium on the 6-year Treasury security?

Question

Quizplus · Accepted Answer

To calculate the maturity risk premium, we need to use the formula: 
Maturity risk premium = (6-year Treasury rate - expected average future short-term interest rates) - inflation premium

First, we need to calculate the expected average future short-term interest rates:

- For Year 1: 3-year Treasury rate = 7.00%
- For Year 2: [(3-year Treasury rate + expected inflation premium in Year 1) + (6-year Treasury rate - expected inflation premium in Year 3 and beyond)] / 2 
= [(7.00% + 1.75%) + (7.25% - 2.40%)] / 2 = 6.55%
- For Year 3 and beyond: We can assume that the average future short-term interest rate will be equal to the 6-year Treasury rate, which is 7.25%.

Next, we can plug in the numbers to calculate the maturity risk premium:

Maturity risk premium = (7.25% - 6.60%) - 2.25% = 1.10%

Therefore, the best choice is C, 1.10%.

Interest Rates the Wall Street Journal Reports That the Rate