the expected return of 1 year T Note

CFA Level III Economics
#1

The following data is given:

To find the expected return of 1 year T note, the answer is 1.2% + 2.6%.

Is long term inflation expectation an appropriate component of 1 year T note expected return?

Real risk-free interest rate 1.2% Current inflation rate 2.2% Spread of 10-year over 1-year Treasury note 1.0% Long-term inflation expectation 2.6% 10-year MBS prepayment risk spread (over 10-year Treasuries)a 95 bps 10-year call risk spread 80 bps 10-year BBB credit risk spread (over 10-year Treasuries) 90 bps

#2

I think it’s appropriate because short-term inflation forecasts aren’t that accurate. Sure long-term is flawed too but it’s better than short-term.

#3

The key word here is not so much “long term” as “expected”.

This is the Risk Premium Approach model from the economics reading. You just keep on adding premiums as appropriate for the type of bond. Current inflation is not a risk/uncertainty. It is a fact.

#4

Thank you for the clear explanation