Liquidity Premium Hypothesis One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

Question

Quizplus · Accepted Answer

According to the liquidity premium hypothesis:

2-year Treasury yield = 1-year Treasury yield + expected increase in 1-year yield + liquidity premium
= 5.50% + 0.25% + 0.075%
= 5.662%

Therefore, the current rate on two-year Treasury securities should be 5.662%.

Liquidity Premium Hypothesis One-Year Treasury Bills Currently Earn 5