Suppose that the current one-year rate (one-year spot rate) and expected one-yea

Question

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following 3 years (i.e., years 2,3 and 4 respectively) are as follows:
1R1 = 5%, E(2r1)= 6%, E(3r1) = 7.5% E(4r1) = 7.85%
Using the unbiased expectations theory, calculate the current (long-term) rates for three-year and four-year -maturity Treasury securities.

Possible Answers:

One year: 6.16 %; two-year 6.58%

One year: 6.16 %; two-year 6.78%

One year: 6.25 %; two-year 6.45%

One year: 5.95 %; two-year 6.45%

Explanation / Answer

1R3         = [(1+.05)(1+.06)(1+.075)]1/3

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