Question

Show working please

Consider the same short-term interest rates as in problem 4 above. If the yield on a discount bond that matures in 4 years is 8.25%, then according to liquidity premium theory, the premium attached to the 4 year discount bond is?

Ref. question

Analysts predict that short-term interest rates over the next 4 years will be as follows: 13%, 2%, 7%, and 10%, respectively. According to expectations theory, the yield on a discount bond with a three year maturity will be ____ and yield on bond with a four year maturity will be ____.

Answer #1

According to expectations theory, the short term interest rates in the future should on average determine the yield of the bond for a particular period.

Hence, with the 4 given interest rates, the expected yield of the 4 year bond will be

= (1.0792-1) * 100

= 7.92%

The liquidity premium theory, presents a more practical approach to estimating the bond yield. It takes into consideration the interest rate risk over the 4 years to which the investor is exposed to. So, it includes a liquidity premium over the expectations theory yield to compensate the investor for interest rate risk. Such a bond also guarantees liquidity in 4 years and hence charges more for it.

So,

Liquidity premium = Actual 4-year bond yield - Bond Yield as per expectations theory

Liquidity premium = 8.25% - 7.92%

Liquidity premium = 0.33%

Analysts predict that short-term interest rates over the next 4
years will be as follows: 5.5%, 4%, 1.1%, and 10%, respectively.
According to expectations theory, the yield on a discount bond with
a three year maturity will be ____ and yield on bond with a four
year maturity will be ____.
Group of answer choices
3.05%; 5.55%
3.05%; 5.15%
3.53%; 5.55%
3.53%; 5.15%
Consider the same short-term interest rates as in problem 4
above. If the yield on a discount...

(b) (i) Short term (one year) interest rates over the next 6
years will be 0.5%, 0.6%, 0.7%,
0.76%, 0.80% and 0.84%. Using the expectation theory, what will be
the interest rates
on a three-year bond? [2 marks]
(ii) Predict the one-year interest rate three years from today
if interest rates are 4%,
4.5%, 4.75% and 5% for bonds with one to four years to maturity and
respectively
liquidity premiums are 0%, 0.1% , 0.15% and 0.2%. [3 marks]
(c)...

According to the liquidity premium theory of the term structure
of interest rates, if the one-year bond rate is expected to be
3%, 6%, and 9% over each of the next three years, and if the
liquidity premium on a three-year bond is 3%, then the interest
rate on a three-year bond is _?

The one year interest rates in the future 5 years starting from
2020 are respectively, 1%, 2%, 3%, 4% and 5%. Estimate the interest
rates of the following bonds issued in 2020 using the expectations
theory.
a. Two year bond
b. Three year bond
c. Four year bond
d. Five year bond
2. Draw a yield curve using above data.
3. What will happen to the yield curve if you incorporate
liquidity premium theory to make estimates of future interest...

If the expected path of 1-year interest rates over the
next five years is 1%, 2%, 3%, 4%, and 5%, the expectations theory
predicts which maturity of bond with the highest interest rate
today? Assume that liquidity premium for the bonds of 1 to 5 years
to maturity is 0%, 0.1%, 0.13% 0.2%, and 0.3% respectively,
calculate YTM of 1 to 5 year bonds.

1-According to the expectations theory of the term structure of
interest rates,
A
a long-term interest rate is equal to the average of current and
expected future short-term interest rates.
B-
the yield curve is always flat.
C-
a short-term interest rate has no relation to long-term interest
rates.
D- a short-term interest rate is equal to the average of current
and expected future long-term interest rates.
2-The expectations theory of yield curves is not very realistic
because
A-
a...

4. Assume that short-term rate, r1 = 6%, and that the
expected market rates,
E(r 12 ) = 7 % and E(r 23 ) = 9 % . Also assume that the
unbiased expectations theory holds such that the forward rates are
identical to expected spot rates.
a. What should be the current price of a 3-year, $1000 bond
with a 12% coupon rate? Assume annual coupon payments.
b. What is the yield-to-maturity for this bond?

Consider the following term structure:
Term Yield
1 1.5%
2 2.3%
3 3.5%
4 3.7%
Compute
the implied forward rate on a one-year security 1 year from now and
2 years from now. What is the economic interpretation
of these rates according to the pure expectations theory?
…according to the liquidity preference (modified expectations)
theory? Suppose that you believe that the actual future one-year
rates will be greater than the implied forward rates....

The table below shows current and expected future one-year
interest rates. Year One-Year Bond Rate 1= 3% 2= 4% 3.=5% 4.= 8% A.
Assuming that the expectations theory is the correct theory of the
term structure, calculate the current interest rate for a four-year
bond (predicted by that theory). Show your work and include a
one-sentence explanation. B. Assume now that the liquidity premium
theory is the correct theory of the term structure. If the actual
interest rate on a...

If the expected path of one-year interest rates over the next
four years is 5 percent, 4 percent, 3 percent, and 2 percent. Draw
the yield curve under the expectations theory. Now, assume
liquidity premium are 0.25 for 2 year, 0.5 for 3 year and 0.75 for
4 year bonds, draw on the same graph (ideally in different color)
the yield curve under the liquidity premium theory.

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