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zot6 - 7 Future interest rates when there is an MRP 1.51...

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Unformatted text preview: 7. Future interest rates when there is an MRP 1.51 Suppose the interest rate on a 1-year Treasury security is 6.20% and the interest rate on a 2-year Treasury security is 6.80%. However, the 2-year security has a maturity risk premium of 0.1%. What is the market's estimate of the 1-year Treasury rate one year from now? 0 7.00% 0 7.10% 4 Q 7.20% O 7.30% 0 7.40% Explanation: Close A The pure expectations theory does not hold in this case because there is a maturity risk premium. You need to adjust the 2-year rate to reflect the maturity risk premium, and then solve like before: (1 + 2-year rate - MRP) = [(1 + 1-year rate) (1 + 1-year rate in one year)]1”2 (1 + 0.0680 — 0.001) = [(1 + 0.0620) (1 + )()]11’2 (1.0670)2 = (1.0620) (1 + X) (1.138489) x (1.0620) = (1 + X) 1.072024 = (1 + X) 0.072024, or 7.20% = X o - _ . QNA 2.71 (c; 2004—20 10 Aplia. All rights reserved. '°' Paints. 1“ Save 3‘ “mm“ ...
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