Suppose the real risk-free rate is 3.00%,the average expected future inflation rate is 6.60%,and a maturity risk premium of 0.10% per year to maturity applies,i.e. ,MRP = 0.10%(t),where t is the years to maturity.What rate of return would you expect on a 1-year Treasury security,assuming the pure expectations theory is NOT valid? Include the cross-product term,i.e. ,if averaging is required,use the geometric average.(Round your final answer to 2 decimal places. )
A) 7.62%
B) 9.50%
C) 9.90%
D) 11.18%
E) 10.69%

Question

Quizplus · Accepted Answer

The expected rate of return on a 1-year Treasury security is calculated as the sum of the real risk-free rate, the average expected inflation rate, and the maturity risk premium. Thus, the rate is 3.00% + 6.60% + 0.10%(1) = 9.70%. However, since the cross-product term is included, the geometric average is used: (1 + 0.03) * (1 + 0.066) - 1 + 0.001 = 9.90%.

Suppose the Real Risk-Free Rate Is 3