Recall that on a one-year Treasury security the yield is 4.9200% and 5.9000% on

Question

Recall that on a one-year Treasury security the yield is 4.9200% and 5.9000% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the tworyear security does and it is 0.3000%, what is the market's estimate of the one-year Treasury rate one year from now? 7.159096 5.3380% 6.2800% 7.9760% Suppose the yield on a two-year Treasury security is 5.83%, and the yield on a five-year MM Assuming that the pure expectations theory is correct, what is the market's estimate of the three-year Treasury rate two years from now? aunsecu 5.46% 6.69% 6.53% 6.45% 100

Explanation / Answer

One Year treasury yield is 4.92% and 2 year yield is 5.9-0.3 = 5.26%

Now, let markets estimate of the one year Treasury rate one year from now = r, then

(1+4.92%) * (1+r) = (1+5.6%)^2

i.e. 1.0492*(1+r) = 1.115136

1+r = 1.0628

or r = 6.28%

Hence Choice C is the correct answer.

Similar to the above let the market's estimate of the 3 year treasury rate 2 years from now is r

then, (1+5.83%)^2*(1+r)^3 = (1+6.2%)^5 = 1.350898

1.11999889 * (1+r)^3 = 1.350898

1+r = (1.206160)^(1/3) = 1.0644738

r = 6.44%

Hence Choice D is the correct answer.

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