You can calculate the yield curve, given inflation and maturity-related risks. Looking at the yield curve, you can use the information embedded in it to estimate the market's expectations regarding future inflation, risk, and short-term interest rates. The -Select- ✓theory states that the shape of the yield curve depends on investors' expectations about future interest rates. The theory assumes that bond traders establish bond prices and interest rates strictly on the basis of expectations for future interest rates and that they are indifferent to maturity because they don't view long- term bonds as being riskier than short-term bonds. For example, assume that you had a 1-year T-bond that yields 1.6% and a 2-year T-bond that yields 2.3%. From this information you could determine what the yield on a 1-year T-bond one year from now would be. Investors with a 2-year horizon could invest in the 2-year T-bond or they could invest in a 1-year T-bond today and a 1-year T-bond one year from today. Both options should yield the same result if the market is in equilibrium; otherwise, investors would buy and sell securities until the market was in equilibrium. Quantitative Problem: Today, interest rates on 1-year T-bonds yield 1.6%, interest rates on 2-year T-bonds yield 2.3%, and interest rates on 3-year T-bonds yield 3.8%. 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. %
You can calculate the yield curve, given inflation and maturity-related risks. Looking at the yield curve, you can use the information embedded in it to estimate the market's expectations regarding future inflation, risk, and short-term interest rates. The -Select- ✓theory states that the shape of the yield curve depends on investors' expectations about future interest rates. The theory assumes that bond traders establish bond prices and interest rates strictly on the basis of expectations for future interest rates and that they are indifferent to maturity because they don't view long- term bonds as being riskier than short-term bonds. For example, assume that you had a 1-year T-bond that yields 1.6% and a 2-year T-bond that yields 2.3%. From this information you could determine what the yield on a 1-year T-bond one year from now would be. Investors with a 2-year horizon could invest in the 2-year T-bond or they could invest in a 1-year T-bond today and a 1-year T-bond one year from today. Both options should yield the same result if the market is in equilibrium; otherwise, investors would buy and sell securities until the market was in equilibrium. Quantitative Problem: Today, interest rates on 1-year T-bonds yield 1.6%, interest rates on 2-year T-bonds yield 2.3%, and interest rates on 3-year T-bonds yield 3.8%. 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. %
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
Related questions
Question
Transcribed Image Text:You can calculate the yield curve, given inflation and maturity-related risks. Looking at the yield curve, you can use the information embedded in it to estimate the market's expectations regarding
future inflation, risk, and short-term interest rates. The -Select-
theory states that the shape of the yield curve depends on investors' expectations about future interest rates. The theory
assumes that bond traders establish bond prices and interest rates strictly on the basis of expectations for future interest rates and that they are indifferent to maturity because they don't view long-
term bonds as being riskier than short-term bonds. For example, assume that you had a 1-year T-bond that yields 1.6% and a 2-year T-bond that yields 2.3%. From this information you could
determine what the yield on a 1-year T-bond one year from now would be. Investors with a 2-year horizon could invest in the 2-year T-bond or they could invest in a 1-year T-bond today and a 1-year
T-bond one year from today. Both options should yield the same result if the market is in equilibrium; otherwise, investors would buy and sell securities until the market was in equilibrium.
Quantitative Problem:
Today, interest rates on 1-year T-bonds yield 1.6%, interest rates on 2-year T-bonds yield 2.3%, and interest rates on 3-year T-bonds yield 3.8%.
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.
%
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 6 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, economics and related others by exploring similar questions and additional content below.Recommended textbooks for you
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (12th Edition)
Economics
ISBN:
9780134078779
Author:
Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher:
PEARSON
Engineering Economy (17th Edition)
Economics
ISBN:
9780134870069
Author:
William G. Sullivan, Elin M. Wicks, C. Patrick Koelling
Publisher:
PEARSON
Principles of Economics (MindTap Course List)
Economics
ISBN:
9781305585126
Author:
N. Gregory Mankiw
Publisher:
Cengage Learning
Managerial Economics: A Problem Solving Approach
Economics
ISBN:
9781337106665
Author:
Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
Publisher:
Cengage Learning
Managerial Economics & Business Strategy (Mcgraw-…
Economics
ISBN:
9781259290619
Author:
Michael Baye, Jeff Prince
Publisher:
McGraw-Hill Education