Using the expectations hypothesis theory for the term structure of interest rate

Question

Using the expectations hypothesis theory for the term structure of interest rates, determine the expected return for securities with maturities of two, three, and four years based on the following data. (Input your answers as a percent rounded to 2 decimal places.)

1-year T-bill at beginning of year 1: 6 %

1-year T-bill at beginning of year 2: 7 %

1-year T-bill at beginning of year 3: 10 %

1-year T-bill at beginning of year 4: 11 %

Expected Return:

2-year security

3-year security

4-year security

Explanation / Answer

Expected Return

2 year Security = (6%+7%) /2 = 6.5%

3 year Security = (6%+7%+10%)/3 = 7.67%

4 year Security = (6%+7%+10%+11%)/4 = 8.5%

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