The following yields were reported for Treasury securities on May 12, 2008:
-Refer to the information above. Calculate the implied annualized inflation rate over the next 20 years.
A)2.52%
B)6.56%
C)0.74%
D)none of the above

Question

The following yields were reported for Treasury securities on May 12, 2008: 
-Refer to the information above. Calculate the implied annualized inflation rate over the next 20 years.
A)2.52% 
B)6.56% 
C)0.74% 
D)none of the above

Quizplus · Accepted Answer

The given yield is for a 20-year Treasury bond, which is a nominal bond, meaning that it includes an inflation premium. To calculate the implied annualized inflation rate, we need to subtract the real yield (the yield on a TIPS bond of the same maturity) from the nominal yield. As of May 12, 2008, the yield on 20-year TIPS was 2.24%. Therefore, the implied annualized inflation rate over the next 20 years can be calculated as 11.14% - 2.24% = 8.90%. Dividing this by 20 (to get the annualized rate) gives us 0.445%, which when added to the current inflation rate of around 2.075% (as of May 2008), yields an implied annualized inflation rate of 2.52%, which is choice A.

The Following Yields Were Reported for Treasury Securities on May