Question

One-year Treasury securities yield 4.25%. The market anticipates that 1 year from now, 1-year Treasury securities will yield 6.9%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury securities? Calculate the yield using a geometric average.

Answer 1

Answer:

5.57%

Explanation:

Assuming that pure expectation theory holds, then the compounded returns of 1 year treasury security rate multiplied by the compounded return of 1 year security rate 1 year from now is equal to the compounded return of the 2 year treasury rate.

1 year treasury security rate = 4.25%

1 year treasury security rate 1 year from now = 6.9%

To solve, we have

1.0425 * 1.069 = (1 + x)²

1.1144 = (1 + x)², finding the square root of both sides

√1.1144 = 1 + x

1.0557 = 1 + x

x = 1.0557 - 1

x = 0.0557

Therefore, the yield today for 2 year treasury securities is 5.57%