Assume that the pure interest rate is expected to be 3% for the foreseeable future, and inflation is expected to be 3%, 4% and 5% for each of the next three years and 6% thereafter. What is the base rate component for a 10-year bond?

Question

Quizplus · Accepted Answer

The base rate component is calculated by adding the pure interest rate to the average expected inflation rate over the bond's term. The average inflation rate for the 10 years is (3% + 4% + 5% + 6%*7)/10 = 5.3%. Adding the pure interest rate of 3% gives 8.3%, but since the closest option is 8.20%, we choose D.

Assume That the Pure Interest Rate Is Expected to Be