Question

Unbiased Expectations Theory One-year Treasury bills currently earn 4.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 4.65 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

4.5000%

9.1500%

4.5750%

4.6500%

Answer 1

The current rate on two-year treasury securities is calculated as below:

Current Rate on Two-Year Treasury Securities = [(1+ Current Rate on 1-Year Treasury Bills)*(1+ Rate on Treasury Bills One Year from Now)]^(1/2) - 1

_____

Solution:

Here, Current Rate on 1-Year Treasury Bills = 4.50% and Rate on Treasury Bills One Year from Now = 4.65%

Using these values in the above formula, we get,

Current Rate on Two-Year Treasury Securities = [(1+4.50%)*(1+4.65%)]^(1/2) - 1= 4.5750% (which is Option C)