If a oneyear bond currently yields 5 and twoyear bond curren

If a one-year bond currently yields 5% and two-year bond currently yields 6% and term premium for two-year bonds is 0.5%, the liquidity premium theory predicts that the expected one year interest rate next year is

Solution

Ans

Here interest rate on long term bond is average of short term bonds plus liquidity premium

So =5+6/2 +0.5=6