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 three years (i.e., years 2, 3 and 4 respectively) are as follows: 1R 1 = 5 percent, E( 2r 1) = 6 percent, E( 3r 1) = 7.5 percent E( 4r 1) = 7.85 percent Using the unbiased expectations theory, calculate the current (long-term) rates for three-year- and four-year-maturity Treasury securities.

One-year: 6.16 percent; Two-year: 6.58 percent

One-year: 6.16 percent; Two-year: 6.78 percent

One-year: 6.25 percent; Two-year: 6.45 percent

One-year: 5.95 percent; Two-year: 6.45 percent

Explanation / Answer

Select - A

One-year: 6.16 percent; Two-year: 6.58 percent

1R3 = [ (1.05)*(1.06)*(1.075) ]1/3 - 1 = 1.0616 - 1 = 0.0616 ........... (or) 6.16 %

1R4 = [ (1.05) * ( 1.06) * ( 1.075) * ( 1.0785) ]1/4 - 1 = 1.0658 - 1 = 0.0658 ......... (or) 6.58 %

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