The real risk-free rate is 3.05%, inflation is expected to be 3.60% this year, and the maturity risk premium is zero. ignoring any cross-product terms, i. e., if averaging is required, use the arithmetic average, what is the equilibrium rate of return on a 1-year treasury bond?

Ans. The equilibrium rate of return on a 1-year Treasury bond is 6.65% (please check the explanation)

Explanation:

Hi, well, this type of bonds exist so people can avoid the time value of money risk, in other words, to keep money save from inflation and provide a risk free return at the same time. From a part of the text I can tell that the person who wrote it wanted to add up the risk free rate and the inflation rate, that is 3.05%+3.60% =6.65%.

This is why I wrote this answer, but the truth is that since they are both effective rates (risk free rate and inflation), they need to be add as effective rates, that is:

Therefore

So the real equilibrium rate of return is 6.76%, but for the sake of the question, I wrote 6.65%.

Best of luck.

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