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5. Nominal interest rates and yield curves Economic forecasters predict that the rate of inflation will hold steady at 2% per year indefinitely. The table below shows the nominal interest rate paid on Treasury securities having different maturities.

Maturity Nominal rate of return

3 months 5%

2 years 6

5 years 8

10 years 8.5

20 years 9

Approximately what real interest rate do Treasury securities offer investors at each maturity?


If the nominal rate of interest paid by every Treasury security above suddenly dropped by 1.5% without any change in inflationary expectations, what effect, if any, would it have on your answers in part a? Explain.


Using your findings in part a, draw a yield curve for U.S. Treasury securities. Describe the general shape of the curve and explain what it says about the future direction of interest rates under the expectations theory.


What would a follower of the liquidity preference theory say about how the preferences of lenders and borrowers tend to affect the shape of the yield curve drawn in part c?


What would a follower of the market segmentation theory say about the supply and demand for long-term loans versus the supply and demand for short-term loans given the yield curve constructed for part c of this problem?

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