Suppose current interest rates on Treasury securities are as follows: Maturity Y

Question

Suppose current interest rates on Treasury securities are as follows:
                       Maturity          Yield
                       1 year                 5.0
                       2 years               5.5
                       3 years               6.0
                       4 years               5.5
Using the expectations theory, compute the expected interest rates (yields) for each security one year from now. What will the rates be two years from today and three years from today?

Please show all work.

Explanation / Answer

One year from now:
expected rate for 1 year=1.055^2/1.05-1=6.0024%
expected rate for 2 years=(1.06^3/1.05)^(1/2)-1=6.5036%
expected rate for 3 years=(1.055^4/1.05)^(1/3)-1=5.6672%

2 years from now:
expected rate for 1 year=1.06^3/1.055^2-1=7.0071%
expected rate for 2 years=(1.055^4/1.055^2)^(1/2)-1=5.5%

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