Question

Based on economists' forecasts and analysis, one year T-Bill rates and liquidity premiums for the next four years are expected to be as follows: 1R1 = 5.65, E(2r1) = 6.75, E(3r1) = 6.85, E(4r1) = 7.15. Using the liquidity premium hypothesis, plot the current yield curve. Make sure to label the axes on the graph and identify the four annual rates on the curve both on the axes and on the yield curve itself.

Answer 1

To plot the current yield curve using the liquidity premium hypothesis, we need to plot the one-year T-Bill rates and the liquidity premiums for the next four years. The four annual rates are: Year 1: 5.65%, Year 2: 6.75% (expected), Year 3: 6.85% (expected), and Year 4: 7.15% (expected).

Step-by-step explanation:

To plot the current yield curve using the liquidity premium hypothesis, we need to plot the one-year T-Bill rates and the liquidity premiums for the next four years. The four annual rates are:

• Year 1: 5.65%
• Year 2: 6.75% (expected)
• Year 3: 6.85% (expected)
• Year 4: 7.15% (expected)

We plot these rates on the y-axis and the corresponding years on the x-axis, marking the points accordingly. Connecting these points will give us the current yield curve.