The yield on a one-year Treasury security is 5.1500%, and the two-year Treasury
ID: 2759015 • Letter: T
Question
The yield on a one-year Treasury security is 5.1500%, and the two-year Treasury security has a 6.1800% yield. Assuring that the pure expectations theory is correct, what is the market's estimate of the one-year Treasury rate one year from now? 9.1694% 6.1370% 7.2200% 8 2308% Recall that on a one-year Treasury security the yield is 5.1500% and 6.1800% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0 3500%. What is the market's estimate of the one-year Treasury rate one year from now? 7.4210% 8.2680% 6.5100% 5.5340% Suppose the yield on a two-year Treasury security is 5 83%, and the yield on a five-year Treasury security is 6.20%. Assuming that the pure expectations theory is correct, what is the market's estimate of the three-year Treasury rate two years from now? 6 45% 6 61% 7.10% 6 69%Explanation / Answer
Answer:
From (1 + 0Rn)n = (1 + 0R1) * (1 + 1R2) * (1 + 2R3) * … * (1 + nRn-1) * [1 + E(n-1Rn)],
(1 + 0R2 – MRP)2 = (1 + 0R1) * [1 + E(1R2)] (1 + 0.0788 – 0.002)2 = (1.0584) * [1 + E(1R2)]
E(1R2) = (1.0618)2 / (1.0515) – 1 = 7.22%
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