Future-looking interest rate expectations for 5 periods are as follows: 3%, 4%, 3.5%, 4.5%, 4%. Additionally, investors charge a liquidity premium of 0.5% per year. a) Draw the yield curve under expectations theory. What is its shape? b) Draw the yield curve under the liquidity premium theory. What is its shape?

Future-looking interest rate expectations for 5 periods are as follows: 3%, 4%, 3.5%, 4.5%, 4%. Additionally, investors charge a liquidity premium of 0.5% per year. a) Draw the yield curve under expectations theory. What is its shape? b) Draw the yield curve under the liquidity premium theory. What is its shape?

Survey Of Economics

10th Edition

ISBN:9781337111522

Author:Tucker, Irvin B.

Publisher:Tucker, Irvin B.

Chapter20: Monetary Policy

Section: Chapter Questions

Problem 3SQP

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Determinants of Interest Rate for Individual Securities A particular security's default risk premium is 3.10 percent. For all securities, the inflation risk premium is 2.10 percent and the real interest rate is 2.30 percent. The security's liquidity risk premium is .80 percent and maturity risk premium is 1.00 percent. The security has no special covenants. What is the security's equilibrium rate of return?
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1. Nominal Interest Rates/Yield Curves Forecasters predict that the annual rate of inflation will continue to be 1.2% for the foreseeable future. The nominal interest rate of Treasury securities with different maturities is shown below: Maturity Nominal Rate of Return 2.2% 2.6% 3,2% 3.8% 4.5% 1 year 2 years 5 years 10 years 20 years a. Plot the yield curve using Excel b. What shape is the yield curve? What does it say about the future direction of interest rates under the expectations theory? c. Approximately what real interest rate do Treasury securities offer investors at each maturity? d. If the nominal rate of interest paid by every Treasury security above suddenly increased by 1.5%, without any change in inflationary expectations, what effect, if any, would it have on your answers to part c? Explain.
Suppose you observe that short-term interest rates are higher than long-term interest rates. a. What expectations must people have regarding future interest rates? b. Why might the above relationship signal a recession? Why might it not? c. What will the yield curve for this problem look like? Q4 Why is the fact that stock prices follow a random walk a signal of stock market efficiency? What would have to be true if stock prices did not follow a random walk?
Under the Pure Expectations Theory, if these investors believe that interest rates will rise in the near future, a. Two statements are correct. b. they will make up for the lower short-term yield when the short-term securities mature, and they reinvest at a higher rate (if interest rates rise) at maturity. c. All statements are correct. d. the large supply of funds in the short-term market will force annualized yields down, while the reduced supply of long-term funds forces long-term yields up. e. they will invest their funds mostly in the short-term risk-free securities so that they can soon reinvest their funds in securities that offer higher yields after interest rates increase. f. their actions cause funds to flow into the short-term market and away from the long-term market. g. Three statements are correct.
(a) One of your colleagues is looking at the yield curve expressed by the information below and asks for an explanation as to why it has the current shape. Describe the shape of the term structure presented in the table below. Explain the shape using the two forms of the “biased” expectations theory your answer should define the two forms, and explain why they are referred to as “biased”. Maturity (T) Years r(1) r(2) r(3) r(4) r(5) r(6) r(7) r(8) r(9) r(10) Spot Rate (%) 2.4711 2.4527 2.4745 2.4518 2.3187 2.2438 2.2403 2.3354 2.4373 2.8747 Please refer to attached image. (b) You are considering purchasing a bond between settlement periods with a 6% coupon rate and 4 semi-annual coupon payments remaining. There are 182 days in the coupon period and the days between the last coupon period and the settlement date is 66. What is the…
(1+ i) = (1 – p)(1+i+x)+p(0) where p is the probability the bond does not pay at all (the bond issuer is bankrupt) and has a zero return, i is the nominal policy interest rate, and x is the risk premium. a. If the probability of bankruptcy is zero, what is the rate of interest on the risky bond? b. Calculate the probability of bankruptcy when the nominal interest rate for a risky borrower is 8% and the nominal policy rate of interest is 3%. c. Calculate the nominal interest rate for a borrower when the probability of bankruptcy is 5% and the nominal policy rate of interest is 4%.
True or false? According to the expectations theory of term structure, buyers of bonds prefer short-term to long-term bonds. Question 20 options: True False
The accompanying graph represents the market for loanable funds in the hypothetical country of Bunko. Assume the market is initially in equilibrium and inflation expectations are 2%. a. Adjust the graph to demonstrate the effects of inflation expectations increasing from 2% to 4%. b. What is the real interest rate after the change in inflation expectations? 3% 2% 7% O 5% Interest rate (%) 10 9 8 7 5 3 2 1 0 0 2 Market for Loanable Funds D 4 6 8 10 12 14 16 Quantity of loanable funds (billions of $) 18 S 20