Question

According to the pure expectations theory, and given the current Treasury yields shown in the table below, the expected yield on a 2 year Treasury security one year from today would be:  

Maturity (years)	Treasury Yield
1	2%
2	3%
3	5%

Answer 1

(1 + 3 year Treasury yield)³ = (1 + 1 year Treasury yield) * (1 + Expected yield on a 2 year Treasury security one year from today)²

(1 + 5%)³ = (1 + 2%) * (1 + Expected yield on a 2 year Treasury security one year from today)²

(1 + Expected yield on a 2 year Treasury security one year from today)² = (1 + 5%)³ / (1 + 2%)

(1 + Expected yield on a 2 year Treasury security one year from today)² = 1.134926

(1 + Expected yield on a 2 year Treasury security one year from today) = (1.134926)^{(1 / 2)}

(1 + Expected yield on a 2 year Treasury security one year from today) = 1.065329

Expected yield on a 2 year Treasury security one year from today = 0.065329 or 6.5329%