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One-year Treasury bills currently earn 5.40 percent. You expect that one year from now, one-year Treasury...

One-year Treasury bills currently earn 5.40 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.55 percent. The liquidity premium on two-year securities is .175 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

  • 11.1250%

  • 3.7080%

  • 5.4750%

  • 5.5620%

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Answer #1

D. 5.5620%

1R2 = [(1 + 0.0540)(1 + 0.0555 + 0.00175)]0.5 - 1 = 5.5620%

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