Question1: Assume the rate of return on a ten year T-bond is 5.00percent and that on a ten year Treasury Inflation Protected Security (TIP) is 2.10percent. Suppose further that the expected average rate of inflation over the next 10 years is 2.0percent, that the MRP on a ten year T-bond is 0.9percent, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, determine the real risk free rate of return, r*? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
[A] 1.90%
[B] 2.00%
[C] 2.10%
[D] 1.70%
[E] 1.80%
Question2. The real risk-free rate is three percent, inflation is expected to be two percent this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a one year Treasury bond?
[A] 5.10%
[B] 5.20%
[C] 4.90%
[D] 5.00%