Question

According to the liquidity premium theory of the term structure of interest​ rates, if the​ one-year bond rate is expected to be 4​%, 6​%, and 9​% over each of the next three​ years, and if the liquidity premium on a​ three-year bond is 3​%, then the interest rate on a​ three-year bond is _________.

Answer 1

Answer:

9.33%

Explanation:

The computation of the interest rate on a​ three-year bond is shown below:

Data given in the question

Yield on a one-year bond is 4%

For two years, it is 6%

And, for third year, it is 9%

And, the liquidity premium is 3%

So, the interest rate on a three year bond is

= (4% + 6% + 9%) ÷ 3 years + 3%

= 6.33% + 3%

= 9.33%