The YTM for one year bond is 5%, 2-year bonds is 4.5% and 3-year bonds is 3.5%Expectation theory is believed to be true. What are the expected one-year rates over the next threeyears?İ2tİzti3t =İ1,t+1 = 2İ2t — İ1,t = 4%5% +4%izt2i₁t + ii,t+1+ii,t+2==i₁t + ĺ1,t+12=ii 1₁t+2;eii ₁t+2 = 3(3.5%) - 5% -4% = 1.5%= 4.5%33i3t - int - ite5% +4% + 1.5%3Would the answer be lower or higher if liquidity premium theory was believedto be true instead?= 3.5%

The liquidity premium theory is an economic concept that suggests investors require compensation, in…

Answered: The YTM for one year bond is 5%, 2-year…

The YTM for one year bond is 5%, 2-year bonds is 4.5% and 3-year bonds is 3.5% Expectation theory is believed to be true. What are the expected one-year rates over the next three years?

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Question

The YTM for one year bond is 5%, 2-year bonds is 4.5% and 3-year bonds is 3.5%
Expectation theory is believed to be true. What are the expected one-year rates over the next three
years?
İ2t
İzt
i3t =
İ1,t+1 = 2İ2t — İ1,t = 4%
5% +4%
izt
2
i₁t + ii,t+1+ii,t+2
=
=
i₁t + ĺ1,t+1
2
=
ii 1₁t+2
;e
ii ₁t+2 = 3(3.5%) - 5% -4% = 1.5%
= 4.5%
3
3i3t - int - ite
5% +4% + 1.5%
3
Would the answer be lower or higher if liquidity premium theory was believed
to be true instead?
= 3.5%

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