CFA Practice Question
Assume that during the past year the consumer price index increased by 3 percent and the securities listed below returned the following real rates of return.
U.S. Long-term bonds: 3.75%
U.S. Government T-bills: 3.50%
U.S. Long-term bonds: 3.75%
What are the nominal rates of return for each of these securities?
A. 6.81%; 8.86%
B. 6.61%; 6.86%
C. 6.61%; 8.86%
Explanation: The nominal risk-free rate is defined by the following equation: nominal RFR = [(1 + real RFR) x (1 + expected inflation rate)] - 1.
and nominal RFR for long-term bonds = [(1 + .0375) x (1 + .03)] - 1 = .068625 = 6.86%.
In this case, nominal RFR for T-bills = [(1 + .035) x (1 + .03)] - 1 = .06605 = 6.61%
and nominal RFR for long-term bonds = [(1 + .0375) x (1 + .03)] - 1 = .068625 = 6.86%.
User Contributed Comments 6
| User | Comment |
|---|---|
| NickPash | What happened to formula Nominal RFR = RFR+E(INF) |
| mekc | either method would lead you to the conclusion of B as 8.86% is way out |
| boddunah | rfr + inf = nominal rfr used in pure expectations theory of yield curve. |
| shiva5555 | It is the only answer that makes sense, the other spreads are too big. |
| jdizzle | rfr + inf = nominal is only an approximation. The real forumula is: (1 + rfr)*(1+inf)=(1+nominal) |
| MaresaJaden | Thanks Jdizzle. In this case approximation works too but I was confused. |