Disregard cross-product problem


Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 6.50%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 13.54%

b. 11.10%

c. 8.77%

d. 10.21%

e. 10.88%

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Accounting Basics: Disregard cross-product problem
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