One-year Treasury securities yield 6%. The market anticipates that 1-year from now 1-year Treasury securities will yield 4.2%. If the pure expectations theory is correct, what should be the yield today for 2-year Treasury securities?
One year T-bill interest rate= 6.00%
Forward rate 1 year T-bill yield after 1 year =
4.20%
As per pure expectation theory, 2 year interest rate = ((1+1 year
interest rate)^1*(1+1 year forward rate)^1)^(1/2)
-1
(((1+6%)^1*(1+4.2%)^1)^(1/2)) -1
((1.06*1.042)^0.5)) -1
1.050961465 -1
0.05096146456 or
5.10%
So yield on 2 year security will be 5.10%
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