1. Given the following data on yields of 10 year Treasury notes and 10 year TIPS,(treasury inflation protection securities), and assuming that in parts a and b you assume that required real yields to maturity are the same in indexed and regular treasuries of similar maturities, what conclusion do you draw about:
a) Changes in investors' expectation of inflation rates in the US since spring 2015? Give a numerical answer if you can and in any case explain why you think the data indicate a rise, a fall or no change in inflation expectations.
b) Changes in investors required real rates of return on "risk free" rates in the US economy now as opposed to 3 years ago at this time. Explain your answer.
10 Year T-note yield 10 Year TIPS Yield
July 2015: 2.131% .506%
now 1.514% .011%
C) What differences--Other than indexing future cash flows to % changes in the CPI for the 10 year TIPS vs. having cash flows fixed for both coupon rate and maturity value for regular treasuries--could affect the difference in their yields? Explain
2. Suppose that "0" coupon US treasuries due to mature in one year were yielding(annual YTM) .39%, while "0" coupon US treasuries maturing in 2 years were yielding(annual YTM) .71%. If you were a risk neutral investor who wanted to choose between these bonds the one that offered you the highest expected rate of return after 1 year, what would you have to expect about 1 year Treasury yields 1 year from now in order to pick today's 1 year bond? Explain your answer and show calculations