6) Suppose current annualized yields on 1 year US treasury securities are only 0

Question

6) Suppose current annualized yields on 1 year US treasury securities are only 0.28%....while current annualized yields on 2year US treasury securities are 0.69% (note you may assume that both 1 and 2year securities in this example are “0” coupon securities with no payment other than the maturity value on the maturity date. What does this data suggest about financial market expectations of 1-year yields, 1 year from now? Explain…. (Assume investors are risk neutral in these short time horizons with default free treasuries.)

Explanation / Answer

1 years yield = 0.28%

2 year yields = 0.69%

So 1 year yeild , 1 year from now is deoted by "1r1: and is formulated as shown below as per the pure expectation theory of finance

(1+0.0028)*(1+1r1) =(1+0.0069)^2

1r1 = 1.0069^/1.0028 -1

1r1 =0.01101676

1r1 = 1.102%

So one year yields one one year from now should be 1.012%

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