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A one-year-maturity U.S. Treasury bond currently yields 1.50%. Investors predict that one-year Treasury bond rate will increase to 2.10% one year from now and to 2.50% two years from now.

 

problems:

 

a. If U.S. Treasury Bonds are risk free and investors anticipate inflation of 0.60% in coming year, how would the Fisher model describe current one-year rate (in both words and numbers)?

 

b. Suppose expectations hypothesis is exactly true (unbiased), what rate must you see for three-year-maturity Treasury Bond in today's Wall Street Journal?

c. One-year maturity California municipal bond presently yields 1.15%.  If your income level places you in 25% federal tax bracket and 6% state tax bracket (you live here in New York), would you prefer to invest in one-year maturity U.S. Treasury Bond or California municipal bond?

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