problem1: Assume the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is 6.0%. Suppose that the pure expectations theory is NOT valid, and the MRP is zero for a one year T-bond but 0.4% for a 2-year bond. Determine the equilibrium market forecast for one year rates 1 year from now?
problem2: If the pure expectations theory of the term structure is correct, which of the following statements is CORRECT?
[A] The yield on a five year corporate bond should always exceed the yield on a 3-year Treasury bond.
[B] Interest rate price risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
[C] Interest rate price risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.
[D] An upward sloping yield curve would imply that interest rates are expected to be lower in the future.
[E] If a one year Treasury bill has a yield to maturity of 7 percent and a 2-year Treasury bill has a yield to maturity of 8 percent, this would imply the market believes that 1-year rates will be 7.5 percent one year from now.
problem3: 3 year treasury securities yield 5 percent, 5-year treasury securities yield 6 percent, and 8-year treasury securities yield 7%. If the expectations theory is correct, determine the expected yield on 5-year Treasury securities three years from now?
problem4: The real risk-free rate is 3%, inflation is expected to be 2 percent this year, and the maturity risk premium is zero. Ignoring any cross-product terms, determine the equilibrium rate of return on a 1-year Treasury bond?
problem5: Which of the following is CORRECT?
[A] The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
[B] Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted.
[C] The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.
[D] Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.
[E] If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.