A recent edition of The Wall Street Journal reported interest rates of 3.10 percent, 3.50 percent, 3.75 percent, and 3.95 percent for three-year, four-year, five-year, and six-year Treasury security yields, respectively, According to the unbiased expectation theory of the term structure of interest rates, what are the expected one-year rates for year 6?

Question

Quizplus · Accepted Answer

The unbiased expectation theory suggests that the yield of a long-term bond is an average of the short-term interest rates that people expect to occur over the life of the long-term bond. To find the expected one-year rate for year 6, we use the given yields to calculate the implied forward rate. Using the formula for the average interest rate over the 6-year period and solving for the unknown 6th year rate, we find that the expected rate is 4.96 percent.

A Recent Edition of the Wall Street Journal Reported Interest