Problem:
Suppose that it is January 2. During the next three years, economists project that inflation will be 3 percent, 4 percent, and 8 percent, respectively; every year thereafter, inflation is expected to settle at 2 percent. It is estimated that a maturity exists on Treasury securities that equal 0.1 percent for each year that remains until the maturity of a bond. To yield a real risk-free rate, r*, equal to 3 percent,
Required:
Question 1: What would the average nominal interest rate on a five-year Treasury bond have to be?
Question 2: What would the average nominal rate have to be for a 10-year Treasury bond with the same characteristics?
Note: Show supporting computations in good form.