CFA Practice Question

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. 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.

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.
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