Suppose That the Current One-Year Rate (One-Year Spot Rate) and Expected

question 4

Multiple Choice

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following 3 years (i.e., years 2, 3 and 4 respectively) are as follows: ₁R₁ = 5%, E(₂r₁) = 6%, E(₃r₁) = 7.5% E(₄r₁) = 7.85%
Using the unbiased expectations theory, calculate the current (long-term) rates for three-year- and four-year-maturity Treasury securities.

• A) One-year: 6.16%; Two-year: 6.58%
• B) One-year: 6.16%; Two-year: 6.78%
• C) One-year: 6.25%; Two-year: 6.45%
• D) One-year: 5.95%; Two-year: 6.45%

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Definitions:

Capital Budgeting

The process of evaluating and selecting long-term investments that are in line with the goal of maximization of shareholder wealth.

Capital Markets

Financial markets for buying and selling equity and debt instruments, which channel savings and investment between suppliers of capital and users of capital.

Large Sums

Large sums typically refer to a significantly high amount of money in various financial contexts, including investments, transactions, or savings.

Mutually Exclusive Projects

In capital budgeting, projects that automatically exclude one another. Projects are mutually exclusive either because they’re different approaches to doing the same thing or because limited resources preclude doing more than one.