Suppose we observe the following rates: 1R1 = 0.75%, 1R2 = 1.20%, and E(2r1) = 0.907%. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L2? (Do not round intermediate calculations. Round your answer to 3 decimal places.)
Suppose we observe the following rates: 1R1 = 0.75%, 1R2 = 1.20%, and E(2r1) = 0.907%. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L2? (Do not round intermediate calculations. Round your answer to 3 decimal places.)
Expected interest rates after a certain period
The liquidity premium hypothesis like the unbiased expectations hypothesis also brings forward a relationship between the expected Interest rates of the debt securities after a certain period with the current spot rates of the debt securities but the only difference is that the investors get the benefit of liquidity premium as an additional parameter on the long term interest rate after the certain period. The liquidity premium theory like the unbiased expectations theory also states that the long term interest rates are equal to the geometric averages of the shod term interest rates and the current interest rates but it also takes into consideration the effect of liquidity premium while calculating long term interest rate.
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