Question

He Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E(4r1), 5.25 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4?
0.0375 percent

0.504 percent

5.01 percent

5.04 percent

Answer 1

Answer:

1 +1R4= {(1 +1R3)(1 + E(4r1) +L4)}1/4

1.0500 = {(1.0475)^3(1 + 0.0525 +L4)}1/4

(1.0500)^4= (1.0475)3^(1 + 0.0525 +L4)

(1.0500)^4/(1.0475)^3= 1 + 0.0525 + L4

(1.0500)4/(1.0475)^3-1.0525

L4= .0050358564 = 0.504%