Posted by John on .
Now lets consider a different type of government bond, a ten-year inflation indexed bond. Payments on this bond are adjusted for inflation based on the CPI. If inflation rises by five percent, interest payments on this bond will rise by five percent.
Interest rates on this type of bond (excluding the added inflation adjustmen) are very low because again, they include only two of the components of an iterest rate. Which two are most important?
-Positive rate of time prederence
-Expected inflation rate
-Transaction costs of screening and monitoring borrowers
-Risk that the borrowers will default
-General uncertainty about the future
Take a shot, what do you think. Use your last post and my response to guide your thinking