(Interest rate determination) You’ve just taken a job at an investment banking firm

Subject: Business    / Finance
Question
(Interest rate determination) You’ve just taken a job at an investment banking firm and been given the job of calculating the appropriate nominal interest rate for a number of different Treasury bonds with different maturity dates. The real risk-free interest rate that you have been told to use is 2.5 %, and this rate is expected to continue on into the future without any change. Inflation is expected to be constant over the future at a rate of 2.0 %. Since these are bonds that are issued by the U.S. Treasury, they do not have any default risk or any liquidity risk (that is, there is no liquidity-risk premium). The maturity-risk premium is dependent upon how many years the bond has to maturity. The maturity-risk premiums are as follows:.364px;=”” collapse;=”” 12px=””>
BOND MATURES IN:    MATURITY-RISK PREMIUM:
0-1 year    0.05%
1-2 years    0.30%
2-3 years    0.60%
3-4 years

0.90%

The nominal rate of interest on Treasury bonds maturing in 0-1 year should be ________%. (Round to two decimal places.)