P5. A thirty 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 .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.

P5. A thirty 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 .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

To estimate the expected real rate of return on the ten-year U.S. Treasury bond, we need to subtract the expected inflation rate from the nominal interest rate.

Here's the calculation:

Real Rate of Return = Nominal Interest Rate - Expected Inflation Rate

Given:
Nominal Interest Rate on the ten-year U.S. Treasury bond = 2.5%
Expected Inflation Rate = 1.5%

Real Rate of Return = 2.5% - 1.5% = 1.0%

Therefore, the expected real rate of return on the ten-year U.S. Treasury bond is 1.0%.