Current annualized yields on 1 year US treasury securities are only .28%....whil

Question

Current annualized yields on 1 year US treasury securities are only .28%....while current annualized yields on 2year US treasury securities are .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 year US treasury securities yield = 0.28%

2 year US treasury securities yield = 0.69%

Expectations of 1 year yields, 1 year from now is calculation below using expectation theory

1 year yields, 1 year from now = [(1+ 0.69%) ^2 / 1+ 0.028%] – 1

                                                 = (1.013847 / 1.0028) – 1

                                                = 1.10%

Hence, Expectations of 1 year yields, 1 year from now is 1.10%.

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