Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year.What is the real risk-free rate of return,r*? The cross-product term should be considered,i.e.,if averaging is required,use the geometric average.
A)3.68%
B)3.87%
C)4.06%
D)4.26%
E)4.48%

Question

Quizplus · Accepted Answer

The real risk-free rate of return is the nominal risk-free rate minus the expected inflation rate. In this case, the nominal risk-free rate is 7.00% and the expected inflation rate is 3.20%. Therefore, the real risk-free rate of return is 7.00% - 3.20% = 3.80%.

Suppose 1-Year T-Bills Currently Yield 7