A thirty- year U. S. Treasury bond has a 4.0 percent interest rate.
In contrast, a ten- year Treasury bond has an interest rate of 2.5
percent. A maturity risk premium is estimated to be 0.2 percentage
points for the longer maturity bond. Investors expect inflation to
average 1.5 percentage points over the next ten years.
a. Estimate the expected real rate of return on the ten- year U. S. Treasury bond.
b. If the real rate of return is expected to be the same for the
thirty- year bond as for the ten- year bond, estimate the average annual
inflation rate expected by investors over the life of the thirty- year