Chapter 5, Problem 9PROB

(a)

Summary Introduction

Introduction:

Treasury bonds (T-bonds):

These bonds involve earning periodic interest up to maturity (greater than 20 years) and consider government debt securities that are issued by the Federal government of the country.

Expectations theory:

Based on long-term (current) interest rates this theory forecasts the short-term interest rates for the future where an investor receives the same amount of interest by investing in two (one-year bond and two-year bond), one after the other year. It is useful to calculate the expected returns and differentiate the investment returns in business.

To determine: The expected one-year interest rates in the second year by using the expectation theory when the interest rate on one-year treasury bonds is 0.4%, 0.8% on two-year bonds, and 1.1% on three-year T-bonds.

(b)

Summary Introduction

Introduction:

Treasury bonds (T-bonds):

These bonds involve earning periodic interest up to maturity (greater than 20 years) and consider government debt securities that are issued by the Federal government of the country.

Expectations theory:

Based on long-term (current) interest rates this theory forecasts the short-term interest rates for the future where an investor receives the same amount of interest by investing in two (one-year bond and two-year bond), one after the other year. It is useful to calculate the expected returns and differentiate the investment returns in business.

To determine: The expected one-year interest rates in the third year by using the expectation theory when the interest rate on one-year treasury bonds is 1%, 0.9% on two-year bonds, and 0.8% on three-year T-bonds.