Real risk-free rate is expected to remain

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The real risk-free rate is expected to remain at 3 percent. Inflation is expected to be 3 percent this year, and 4 percent next year. The maturity risk premium is estimated to be equal to 0.1%(t - 1), where t = the maturity of a bond (in years). All Treasury securities are highly liquid, and therefore have no liquidity premium. Three-year Treasury bonds yield 0.5 percentage points (0.005) more than two-year Treasury bonds (that is, two-year bond yield plus 0.5%). What is the expected level of inflation in Year 3?

Reference no: EM13729382

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