Suppose we observe the following rates: 1R1 = 4.4%, 1R2 = 5.1%, and E(2r1) = 4.4%.

Suppose we observe the following rates: 1R1 = 4.4%, 1R2 = 5.1%, and E(2r1) = 4.4%. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2? (Round your intermediate calculations to 5 decimal places and final percentage answer to 2 decimal places. (e.g., 32.16))

 

answer

Save your time - order a paper!

Get your paper written from scratch within the tight deadline. Our service is a reliable solution to all your troubles. Place an order on any task and we will take care of it. You won’t have to worry about the quality and deadlines

Order Paper Now

L2 = Liquidity premium for year 2

(1+ 1R2)^2 = (1+ 1R1) x (1+ E(2r1) + L2)

(1+ 5.1%)^2 = (1+ 4.4%) x (1+ 4.4% + L2)

L2 + 1 + 4.4% = 1.051^2 / 1.044

L2 = 1.058046935 -1 – 4.4%

L2 = Liquidity premium for year 2 = 1.40%