Forecasting Interest Rates Assume the current interest rate on a one-year Treasury bond (₁R₁) is 5.00 percent, the current rate on a two-year Treasury bond (₁R₂) is 5.75 percent, and the current rate on a three-year Treasury bond (₁R₃) is 6.25 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, ₃f₁?

Question

Quizplus · Accepted Answer

According to the unbiased expectations theory, the long-term interest rate is equal to the average of current and expected future short-term interest rates. Therefore, the expected one-year interest rate on Treasury bills during year 3 (₃f₁) can be calculated as follows: Expected one-year interest rate on Treasury bills during year 3 (₃f₁) = [(1 + 0.0625)^3 / (1 + 0.0575)^2]^(1/1) - 1 = 0.0726 or 7.26% Therefore, the best choice is C) 7.26%.

Forecasting Interest Rates Assume the Current Interest Rate on a One-Year