CFIN (with MindTap Finance, 1 term (6 months) Printed Access Card) (MindTap Course List)
6th Edition
ISBN: 9781337407342
Author: Scott Besley, Eugene Brigham
Publisher: Cengage Learning
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Chapter 5, Problem 10PROB
Summary Introduction
Expectation theory:
Expectation theory is used to find forward interest rate based on the prevailing long term interest rates.
Calculate the forward rate as follows:
Given five year Treasury bond rate is 3.1%, six year Treasury bond rate is 2.9% and seven year Treasury bond rate is 2.6%.
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Suppose the current interest rate on a one-year bond is 2% and the current interest rate on a two-year bond
is 4%. The term premium on a two-year bond is 1%. According to the expectations hypothesis, what interest
rate should we expect on a one-year bond next year? Answer as a percentage to one decimal place and do
not include symbols (e.g. $, %, commas) in your answer.
Answer:
The interest rate on five-year Treasury bonds is 3.1 percent, the rate on six-year T-bonds is 2.9 percent, and the rate on seven-yearT-bonds is 2.6 percent. Using the expectations theory, compute the expected one-year interest rates in (a) Year 6 only and (b) Year 7 only.
Today, interest rates on 1-year T-bonds yield 1.2%, interest rates on 2-year T-bonds yield 2%, and interest rates on 3-year T-bonds yield 3.3%. a. If the pure expectations theory is correct, what is the yield on 1-year T-bonds one year from now? Be sure to use a geometric average in your calculations. Do not round intermediate calculations. Round your answer to four decimal places.
Chapter 5 Solutions
CFIN (with MindTap Finance, 1 term (6 months) Printed Access Card) (MindTap Course List)
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