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Interest rate determination
youve just taken a job at a investment banking firm and been giving the job of calculating appropriate nominal interest interest rate for a number of different Treasury bonds with different maturity dates. The real risk-free interest rate that you have been told to use is 2.5% and this rate is expected to continue on into the future without any change. Inflation is expected to be constant over the future at a rate of 2.0%. Since these are bonds that are issued by the U.S. Treasury, they do not have any default risk or any liquidity risk. The maturity-risk premium is dependent upon how many years the bond has to maturity the maturity risk premiums are as follows: Bond Matures in Maturity-Risk Premium 0-1 year 0.05% 1-2 years 0.30% 2-3 years 0.60% 3-4 years 0.90%Given this information, what should the nominal rate of interest on Treasury bonds maturing in the above years be?
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