Question

Unbiased Expectations Theory Suppose that the current one-year rate (oneyear spot rate) and expected one-year T-bill rates over the following three years (i.e.,
years 2, 3, and 4, respectively) are as follows:

1R1=7%, E(2r1) =9%, E(3r1) =6.0% E(4r1)=4%

Using the unbiased expectations theory, calculate the current (long-term) rates for
one-, two-, three-, and four-year-maturity Treasury securities. Show your answers in
percentage form to 3 decimal places.
Note that:

Rate for a two year security
= [(1 + 1R1)(1 + E(2r1))] 1/2 - 1

Rate for a three year security
= [(1 + 1R1)(1 + E(2r1))(1 + E(3r1))] 1/3 - 1

Rate for a four year security
= [(1 + 1R1)(1 + E(2r1))(1 + E(3r1))(1 + E(4r1))] 1/4 - 1

Answer 1

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