4. Answer the following questions; A Suppose that the current one-year rate (one

Question

4. Answer the following questions; A 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; ie = 6%, iet+1 = 7%,ift+,-75%,11,t+,-7.85% Using the unbiased expectations theory, calculate the current long-term rates for one, two, three, and four-year maturity Treasury securities. Plot the resulting yields curve. B Suppose we observe the following rates: ¡¡ 10%, i2t = 14%, and i11+1 10%. If = the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2. C You note the following yield curve in the The Wall Street Journal. According to the unbiased expectation theory, what is the one-year forward rate for the period beginning two years from today fi4+2 Maturity Yield one day 2.00% one year 5.50 two years 6.50 three years 9.00

Explanation / Answer

1.
2 year=((1+6%)*(1+7%))^(1/2)-1=6.5%
3 year=((1+6%)*(1+7%)*(1+7.5%))^(1/3)-1=6.8315%
4 year=((1+6%)*(1+7%)*(1+7.5%)*(1+7.85%))^(1/4)-1=7.0852%

2.
14%=(10%+10%)/2+liquidity premium
liquidity premium=4%

3.
=((1+9%)^3)/((1+6.5%)^2)-1
=14.1774%

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