Question

One-year T-bills currently earn 0.36 percent. You expect that one year from now, one-year T-bill rates will increase to 0.41 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Current rate on two-year Treasury securities

Answer 1

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Assuming unbiased expectations theory hold, we will compute the current rates on two-year treasury securites using the formula

i₂ = ((1 + i₁) * (1 +i_e1))^1/2 - 1

where

i₂ = Current rate on 2-year treasury security

i₁ = Current rate on 1-year treasury security

i_e1 = Expected rate on 1-year treasury security

=> i₂ = ((1 + 0.0036) * (1 +0.0041))^1/2 - 1

=> i₂ = 0.003849 ~ 0.38% (Rounded off to two decimal places)