Question

4. The following table shows the price of \$1000 face value 1-year, 2-year, 3-year, 9-year and...

4. The following table shows the price of \$1000 face value 1-year, 2-year, 3-year, 9-year and 10-year US Treasury zero coupon bonds as of March 2018. Use pure expectations hypothesis to determine:

a. the interest rate for the 1-year bond.

b. the expected interest rate on a 1-year bond one year from now, in year 2?

b. the expected interest rate on a 1-year bond two years from now, in year 3?

c. the expected interest rate on a 1-year bond nine years from now, in year 10?

1-yr     2-yr       3-yr       9-yr        10-yr

U.S. Treasury (March 2018)    982.51   965.31   948.41   783.17   759.11

What is the bond market telling us about the future path of 1-year interest rates?

Expected interest rate in year t = (price of year t-1 bond - price of year t bond) / (price of year t-1 bond)

We can calculate these as follows:

 Year = t Price of year t bond Expected interest rate in year t 0 1,000.00 1 982.51 1.7490% 2 965.31 1.7506% 3 948.41 1.7507% 9 783.17 10 759.11 3.0721%

b. the expected interest rate on a 1-year bond one year from now, in year 2? 1.7506%

b. the expected interest rate on a 1-year bond two years from now, in year 3? 1.7507%

c. the expected interest rate on a 1-year bond nine years from now, in year 10? 3.0721%

d. since the interest rates are going up, bond market is forecasting some economic uncertainty which will make money more expensive

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