Question

One-year Treasury bills currently earn 3.25%. You expect that one year from now, 1-year Treasury bill rates will increase to 3.45%. The liquidity premium on 2-year securities is 0.06%. If the liquidity premium theory is correct, what should the current rate be on 2-year Treasury securities?

Answer 1

Answer:

the current rate be on 2-year Treasury securities is 3.38%

Explanation:

The computation of the current rate on the 2-year treasury securities is shown below:

= {(1 + current interest rate) × (1 + increased current interest rate + liquidity premium)^(1 ÷ 2)} - 1

= {(1 + 3.25%) × (1 + 3.45% + 0.06%)^(1 ÷ 2)} - 1

= (1.0325 × 1.0351)^(1 ÷ 2)} - 1

= 3.38%

Hence, the current rate be on 2-year Treasury securities is 3.38%