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problem: Assume the yield to maturity on a one year zero coupon bond is eight percent. The yield to maturity on a two year zero coupon bond is ten percent. Answer the given problems [use semiannual compounding]:

[A]     According to the Expectations Hypothesis, determine the expected one-year rate in the market place for year 2?

[B]    Consider a one-year investor who expects the yield to maturity on a one-year bond to equal 6 percent next year. How should this investor arrange his or her portfolio today? Suppose 100 dollar face value for the above bonds.

[C]     If all investors behave like the investor in [b], what will happen to the equilibrium term structure according to the Expectations Hypothesis?

Basic Finance, Finance

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