Question

The Wall Street Journal reports the rate on three-year Treasury securities is 5.25% and the rate on four-year Treasury securities is 5.50%. The one-year interest rate expected in year four is 6.1%. According to the Liquidity Premium Theory, what is the liquidity premium on the four year Treasury security?

Answer 1

The liquidity premium on the four-year Treasury security is 0.25% or 25 basis points.

Step-by-step explanation:

According to the Liquidity Premium Theory, the liquidity premium on a bond is the additional interest rate investors require in exchange for holding a less liquid security.

In this case, the liquidity premium on the four-year Treasury security can be calculated by subtracting the three-year Treasury rate from the four-year Treasury rate. Therefore, the liquidity premium on the four-year Treasury security is 5.50% - 5.25% = 0.25% (or 25 basis points).