Question

The interest rate on 3-year Treasury securities is currently 6%. The interest rate on 4-year Treasury securities is currently 7%. Assume that the pure expectations theory is correct. To the closest whole percent, what is a reasonable forecast of the rate on 1-year Treasury securities 3 years from now

Answer 1

the one year rate three years into the future will be of 10.05%

Step-by-step explanation:

Both securities will "yield" the same for the first three years

but the 4-year treasury has a premium on the fourth year which makes the yield go up to 7%

`(1+0.06)^3(1+r)=(1.07)^4\\`

`(1+r)= (1.07^4)/(1.06^3) \\r= (1.07^4)/(1.06^3) -1`

r = 0.10057 = 10.05%