Question

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 0.25%. What is the market's estimate of the one-year Treasury rate one year from now? 8.5217% 5.7035% 6.7100% 7.6494% Suppose the yield on a two-year Treasury security is 4.9%, and the yield on a five-year Treasury security is 5.1%. Assuming that the pure expectations theory is correct, what is the market's estimate of the three-year Treasury rate two years from now? 4.86% 5.23% 5.86% 4.55%

Answer 1

a) 1 year rate one year from now = (2 year rate - MRP) x 2 - current 1 year rate

= (6.18% - 0.25%) x 2 - 5.15%

= 6.7100%

b) Similarly,

3 year rate = (5 x 5-year rate - 2 x 2-year rate) / 3 = (5 x 5.1% - 2 x 4.9%) / 3 = 5.23%