To determine the expected interest rate on the one-year Treasury bill two years from March 5, 2010, using the liquidity premium theory, we will need to apply the expectations hypothesis formula along with the provided liquidity premiums (term premiums).

Step-by-step Process:

We are given the following information:

• 1-year Treasury rate (r₁) = 0.40%
• 2-year Treasury rate (r₂) = 0.88%
• 3-year Treasury rate (r₃) = 1.47%
• Liquidity premium for the 2-year Treasury (LP₂) = 0.01%
• Liquidity premium for the 3-year Treasury (LP₃) = 0.03%

The liquidity premium theory suggests that the yield on a long-term bond includes both the expected short-term rates and a liquidity (or term) premium. We can use the following formula to determine the expected interest rate on a 1-year Treasury bill two years from now $(E(r₁^{2}))$:

$(1 + r₃)^3 = (1 + r₁) \times (1 + E(r₁^{1})) \times (1 + E(r₁^{2}))$ Where:

• $r₁, r₂, r₃$ are the interest rates for the 1, 2, and 3-year bonds respectively (adjusted for their term premiums).
• $E(r₁^{1})$ is the expected 1-year rate 1 year from today.
• $E(r₁^{2})$ is the expected 1-year rate 2 years from today.

Let's calculate the expected rate!The expected interest rate on the one-year Treasury bill two years from March 5, 2010, is 2.18%.

Would you like more details on the calculation or have any questions?

Here are 5 related questions to consider:

1. How does the liquidity premium theory differ from the expectations hypothesis?
2. Why do longer-term securities generally have higher interest rates?
3. How are term premiums determined in real-world markets?
4. What factors influence the changes in Treasury security yields?
5. How would the expected rate change if the liquidity premium was higher?

Tip: When working with interest rates, always ensure you're using the correct decimal form (e.g., 0.40% = 0.004) to avoid calculation errors.