Answer all of these questions with the right question number next to the correct choice. ANSWER ALL OR NONE
1-What does f1,t+3 = 2.5% mean for a Treasury issued asset?
A)This represents a forward rate that is meaningless today as we cannot calculate it, even using the Expectations Theory
B)Today's 3 year T-Note pays 2.5% for three years, if held to maturity
C)The 3year T-Note will offer 2.5% in 3 years
D)Today's expected 1-year rate three years from now is 2.5%, that is at time "t+3"
2-Given the yield curve below and a forecasted MRPn = 0.25 (n - 1)%, what is the expected 1-year rate forecast by the liquidity theory in the fourth year (3 years from now at time t + 3)? The spot yield curve rates are k(1, t) = 4.75% k(2, t) = 4.95% k(3, t) = 5.25% k(4, t) = 5.35% k(5, t) = 5.45%
5-What is the meaning of a "forward rate"?
A)It is a rate that arises in the forward market for Treasuries
B)It is an average of the Treasury rates that can be calculated from the yield curve rates
C)It is a rate on a 1-year T-Bill that can be calculated today from the yield curve rates as a forecast of the 1-year T-Bill rate in the future.
D)It is a rate on a 1-year T-Bill that explicity appears today in the market regarding the 1-year T-Bill rate in the future
6-The term structure of interest rates may be defined as the relationship between:
A)Stock returns and maturity
B)Interest rates and chronological time
C)Yields and maturities of bonds of different risk classes
D)Yields and maturities of bonds of the same risk class
1). f1,t+3 for a treasury issued asset is the expected 1-year forward rate, 3 years from now. This rate is given as 2.5%. (Option D)
2). k'(4,t) = k(4,t) - MRP4 = 5.35% - 0.25*(4-1)% = 4.60%
k'(3,t) = k(3,t) - MRP3 = 5.25% - 0.25*(3-1)% = 4.75%
f1,4 = [(1+k'(4,t)^4/(1+k'(3,t)^3] -1
= [(1+4.60%)^4/(1+4.75%)^3] -1
= 4.15% (Option B)
5). Forward rate is a rate that is used in the forward market for Treasuries. (Option A)
6). Term structure of interest rates defines the relationship between yields and maturities of bonds belonging to the same risk class. (Option D)
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