Suppose you had bought a $30-$year Treasury bond at a nominal interest rate of $0\mathrm{.}5\%$ and the inflation averages $2\%$ over the next $30$ years. Then the real interest rate would turn out to be $\%.($Hint: Type in the negative sign, if needed.$)$

The quoted $($or nominal$)$ interest rate on a debt security, $r,$ is composed of a real risk$-$free rate, $r^{**},$ plus several premiums that reflect inflation, the security$\text{'}$s risk, its liquidity $($or marketability$),$ and the years to its maturity:

The quoted interest rate, $r=r^{**}+IP+DRP+LP+MRP$

$=r_{RF}+DRP+LP+MRP,$

where

$r=$ the quoted, or nominal, rate of interest on a given security;

$r^{**}=$ the interest rate that would exist on a riskless security if no inflation were expected. It may be thought of as the rate of interest on short$-$term U$.$S$.$ Treasury securities $($indexed Treasury bonds$)$ in an inflation$-$free world. The real risk$-$free rate is not static$-$it changes over time, depending on economic conditions, especially $(1)$ the rate of return that corporations and other borrowers expect to earn on productive assets and $(2)$ people's time preferences for current versus future consumption.

IP $=$ inflation premium. IP is equal to the average expected rate of inflation over the life of the security. The expected future inflation rate is not necessarily equal to the current inflation rate, so IP is not necessarily equal to current inflation.