Suppose the Real Risk-Free Rate Is 4

question 35

Multiple Choice

Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%, 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, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

• A) 6.60%
• B) 6.95%
• C) 7.32%
• D) 7.70%
• E) 8.09%

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