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Liquidity Premium Hypothesis One-year Treasury bills currently earn 2.50 percent. You expected that one year from...

Liquidity Premium Hypothesis One-year Treasury bills currently earn 2.50 percent. You expected that one year from now, one-year Treasury bill rates will increase to 2.75 percent. The liquidity premium on two-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

1R2 =

[(1 + Real interest rate)(1 + Year 2 Rate + Liquidity risk premium)] 1/2 – 1

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