Unbiased Expectations Theory The Wall Street Journal reports that the rate on 4-year Treasury securities is 4.75 percent and the rate on 5-year Treasury securities is 5.95 percent. According to the unbiased expectations hypotheses, what does the market expect the 1-year Treasury rate to be four years from today, E(₅r₁)?

Question

Quizplus · Accepted Answer

According to the unbiased expectations theory, the market expects the future short-term interest rate to be equal to the geometric average of current and expected future long-term interest rates. Therefore, E(₅r₁) = [(1 + 0.0475)(1 + x)^3(1 + 0.0595)^2]^(1/5) - 1, where x is the expected 1-year Treasury rate four years from today. Solving for x, we get x = 0.1089 or 10.89%. Therefore, the best choice is D.

Unbiased Expectations Theory the Wall Street Journal Reports That the Rate