Unbiased Expectations Theory The Wall Street Journal reports that the rate on four-year Treasury securities is 1.60 percent and the rate on five-year Treasury securities is 2.15 percent. According to the unbiased expectations theory, what does the market expect the one-year Treasury rate to be four years from today, E (5r1) ? (LG6-7)

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Marin Cunningham

Business

3 June, 08:08

Unbiased Expectations Theory The Wall Street Journal reports that the rate on four-year Treasury securities is 1.60 percent and the rate on five-year Treasury securities is 2.15 percent. According to the unbiased expectations theory, what does the market expect the one-year Treasury rate to be four years from today, E (5r1) ? (LG6-7)

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Sydney Ware · Answer 1

Explanation: Unbiased Expectations Theory states that current long-term interest rates contain an implicit prediction of future short-term interest rates. More specifically, the theory states that an investor should earn the same amount of interest from an investment in a single two-year bond today as that person would with two consecutive investments in one-year bonds.

From the above question:

1 + 1R5 = { (1 + 1R4) 4 (1 + E (5r1)) }1/51.0215

= { (1.016) 4 (1 + E (5r1)) }1/5 (1.0215) 5

= (1.016) 4 (1 + E (5r1)) (1.0215) 5 / (1.016) 4

= 1 + E (5r1) 1 + E (5r1)

= 1.0438E (5r1) = 4.38%