EBK CFIN
6th Edition
ISBN: 9781337671743
Author: BESLEY
Publisher: CENGAGE LEARNING - CONSIGNMENT
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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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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.
The interest rate on one-year Treasury bonds is 0.4 percent, the rate on two-year T-bonds is 0.8 percent, and the rate on three-year T-bonds is 1.1 percent. Using the expectations theory, compute the expected one-year interest rates in (a) the second year (Year 2 only) and (b) the third year (year 3 only).
The interest rate on one-year Treasury bonds is 0.8 percent, the rate on two-year T-bonds is 0.9 percent, and the rate on three-year T-bonds is 1.0 percent.
Using the expectations theory, compute the expected one-year interest rate in the second year (Year 2 only). Round your answer to one decimal place.
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Using the expectations theory, compute the expected one-year interest rate in the third year (Year 3 only). Round your answer to one decimal place.
%
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- What would be the value of the bond described in Part d if, just after it had been issued, the expected inflation rate rose by 3 percentage points, causing investors to require a 13% return? Would we now have a discount or a premium bond? What would happen to the bond’s value if inflation fell and rd declined to 7%? Would we now have a premium or a discount bond? What would happen to the value of the 10-year bond over time if the required rate of return remained at 13%? If it remained at 7%? (Hint: With a financial calculator, enter PMT, I/YR, FV, and N, and then change N to see what happens to the PV as the bond approaches maturity.)arrow_forwardThe three-year interest rate is 7.40% and the four-year interest rate is 8.6%. The liquidity premium for three-year and four-year bonds are 0.40 and 0.60 respectively. Calculate the adjusted forward rate forecast for three-year periods in the futurearrow_forwardthe current 1-year, 2-year, and 3-year bond interest rates are 3%, 4%, and 5%, respectively, and the 1-year, 2-year, and 3-year term premia are 0, 0.5, and 1 percent, respectively. the expectations theory of the term structure predicts that the expected 1-year bond interest rate is _____% next year and _____% the year afterarrow_forward
- Suppose the yield on a two-year-old Treasury bond is 5 percent and the yield on a one-year Treasury bond is a 4 percent. If the maturity risk premium (MRP) on these bonds is zero (0), what is the expected one-year interest rate during the second year (Year 2)?arrow_forwardWhat is the purchase price for a bond that is paying 6 percent annual coupon rate in Semi-annual payments if its Yield to Maturity is 10 % and it has 10 years and 10 months from its purchase date until its maturity? What is the accrued interest rate? Assume the bond is traded in a year of 366 days when calculating the accrued interest.arrow_forwardTen-year bonds have an interest rate of 6.5 percent, while 15-year bonds have an interest rate of 6.0 percent. If the expectations theory is correct, what does the market believe will be the interest rate on 5-year bonds, 10years from now? 5.5% 5% 12.5% 6.25%arrow_forward
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