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FINANCE - EXPECTED INTEREST RATE - Unbiased Expectations Theory

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3. [5] Suppose we look in the newspaper and find the following rates: the rate on 1-year securities is 4.65%, on a similar 2-year security 6.24%, and a 3-year security 6.67%. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now?

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Solution Preview

THE UNBIASED EXPECTATIONS THEORY

TO FIND THE INTEREST RATE FOR PERIOD 1:

Step 1
Add one to the 2-year security's interest rate. Which results in 1.0624

Step 2
Square this figure.
1.0624*1.0624 = 1.12896376

Step 3
Divide this figure by ...

Solution Summary

Suppose we look in the newspaper and find the following rates: the rate on 1-year securities is 4.65%, on a similar 2-year security 6.24%, and a 3-year security 6.67%. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now?

$2.19
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