A one-year T-bond rate is currently 3% and the one-year rate in 12 months is expected...

A one-year T-bond rate is currently 3% and the one-year rate in 12 months is expected to be 2.5% in addition to a liquidity premium of 0.25%. Based on this information, what do expect the two-year T-bond rate to currently be?

Expert Solution

Liquidity theory says that the longer the duration of the Bond the higher will be the intrest rate because of the intrest rate risk assumed by the bond holder.

Formula = (One year rate+ 2nd year rate)/2 + Liquidity premium

2 year Bond rate = (3%+2.5%)/2 +0.25%

2 Year bond rate = 3%

jeff jeffy answered 2 years ago

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