Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.60%.What rate of return would you expect on a 1-year Treasury security,assuming the pure expectations theory is valid? Disregard cross-product terms,i.e. ,if averaging is required,use the arithmetic average.
A) 6.08%
B) 10.13%
C) 7.70%
D) 8.10%
E) 7.29%

Question

Quizplus · Accepted Answer

According to the pure expectations theory, the expected rate of return on a 1-year Treasury security can be calculated as the sum of the real risk-free rate and the expected rate of inflation. Therefore, the expected rate of return on a 1-year Treasury security can be calculated as follows:

Expected rate of return = Real risk-free rate + Expected rate of inflation
= 3.50% + 4.60%
= 8.10%

Therefore, the correct answer is D) 8.10%.

Suppose the Real Risk-Free Rate Is 3