Concept explainers
(a)
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
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)
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.
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Check out a sample textbook solution- Today, interest rates on 1-year T-bonds yield 1.7%, interest rates on 2-year T-bonds yield 2.5%, and interest rates on 3-year T-bonds yield 3.7%.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. b. If the pure expectations theory is correct, what is the yield on 2-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. c. If the pure expectations theory is correct, what is the yield on 1-year T-bonds two years from now? Be sure to use a geometric average in your calculations. Do not round intermediate calculations. Round your answer to four decimal places.arrow_forwardThe 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.arrow_forwardSuppose you can observe that 1-year bond interest rate is 4%, 2-year bond interest rate is 8%, and 3-year bond interest rate is 10% at time t. It is also known that the term premium on a 2-year bond is 1% and the term premium on a 3-year bond is 1.5%. a) What are the market's expected 1-year bond interest rates for the next two years from time t? b) How to interpret those expected short-term interest rates? (what would be the "possible" economic meanings in the expected short- term interest rates?) Discuss as least two "candidates" to explain them.arrow_forward
- Today, interest rates on 1-year T-bonds yield 1.2%, interest rates on 2-year T-bonds yield 2.6%, and interest rates on 3-year T-bonds yield 3.7%.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. Round your answer to four decimal places. Do not round intermediate calculations. b. If the pure expectations theory is correct, what is the yield on 2-year T-bonds one year from now? Be sure to use a geometric average in your calculations. Round your answer to four decimal places. Do not round intermediate calculations. c. If the pure expectations theory is correct, what is the yield on 1-year T-bonds two years from now? Be sure to use a geometric average in your calculations. Round your answer to four decimal places. Do not round intermediate calculations.arrow_forwardSuppose that the interest rate on one-year bonds is currently 4 percent and is expected to be 5 percent in one year and 6 percent in two years. Using the expectations hypothesis, compute the yields on two- and three-year bonds and plot the yield curve.arrow_forwardSuppose 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_forward
- According to the expectations theory of the term structure of interest, if the 1-year bond rate today is 6.50% p.a., the 2-year bond rate today is 6.70% p.a., and the 3-year bond rate today is 7.00%, what will be the 2-year bond rate next year?arrow_forwardForecasting interest rates Assume the current interest rate on a one-year treasury bond(1R1) is 4.50 percent, the current rate on a two-year treasury bond (1R2) is 5.25 percent, and the current rate on a three-year treasury bond (1R3) is 6.50 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year forward rate expected on treasury bills during year 3, 3f1?arrow_forwardSuppose that the yield curve shows that the one-year bond yield is 8 percent, the two-year yield is 7 percent, and the three-year yield is 7 percent. Assume that the risk premium on the one-year bond is zero, the risk premium on the two-year bond is 1 percent, and the risk premium on the three-year bond is 2 percent. a. What are the expected one-year interest rates next year and the following year? The expected one-year interest rate next year = The expected one-year interest rate the following year b. If the risk premiums were all zero, as in the expectations hypothesis, what would the slope of the yield curve be? The slope of the yield curve would be (Click to select) % %arrow_forward
- The current 1-year, 2-year, and 3-year bond interest rates are 3%, 4%, and 5%, respectively, and the 1-yaer, 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 after. Question 9 options: Blank # 1 Blank # 2arrow_forwardSuppose that the current one-year rate (one-year spot rate) and expected one-year government bonds over years 2, 3 and 4 are as follows: 1R₁ = 4.80%, E(2r₁) = 5.45%, E(3r₁) = 5.95%, E(41) = 6.10% Assume that there are no liquidity premiums. To the nearest basis point, what is the current rate for the four-year-maturity government bond? A. 5.57% B. 5.62% C. 5.83% D. 6.10%arrow_forwardnumerical answers should be calculated to at least two decimal places. Face value of bonds is taken as $100. assume coupon payments are paid once a year. Bond A: term to maturity=10 years, coupon rate = 9.75%, current price = $160.55. Find the current yield and yield to maturity of Bond A. Bond B: term to maturity-5 years, coupon rate = 11.25%, yield to maturity -2.35% p.a. Find the current price of Bond B. From your answer, what do say about this price when compared with the face value of the bond?arrow_forward