Answer:
8.7%
Explanation:
Given that,
Real risk free rate = 5%
Expected inflation:
This year = 3%
Next year = 3.5% and thereafter = 4%
Estimated maturity risk premium = 0.1 × (t - 1)%
t = number of years to maturity
Average inflation rate:
= (3% + 3.5% + 4%) ÷ 3
= 3.5%
Estimated maturity risk premium:
= 0.1 × (t - 1)%
= 0.1 × (3 - 1)%
= 0.2%
Therefore,
Yield on a 3 year treasury note:
= Real risk free rate + Average inflation rate + Estimated maturity risk premium
= 5% + 3.5% + 0.2%
= 8.7%
