The Wall Street Journal reports that the rate on threeyear T

The Wall Street Journal reports that the rate on three-year Treasury securities is 2.63 percent and the rate on four-year Treasury securities is 2.84 percent. The one-year interest rate expected in three years, E(₄r₁), is 3.31 percent. According to the liquidity premium hypotheses, what is the liquidity premium on the four-year Treasury security, L₄? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16))

Solution

(1 + R4)4 = (1+R3)3 * (1 + E(4r1) + L4)

1.0284⁴ = 1.0263³ * (1.0331 + L4)

1.11853 = 1.08099 * (1.0331+L4)

1.0331 + L4 = 1.11853/1.08099 = 1.03473

L4 = 1.03473 - 1.0331 =0.001626

Hence, answer is 0.16%