Question

Describe the “pure expectations theory” of the term structure of interest rates

Answer #1

Expectations theory is aimed to find that, what short term interest rates would be in future based upon the current long term rates. It asserts that forward rate exclusively present the expected future rates.Entire term structure reflects the market expectations of future short-term rates.

So expectations theory is based upon derivation of forward short term rates based upon the current long-term rates and it asserts that forward rate is representative of expected future rates.

Using the Expectations Theory of the term structure,
calculate the interest rates in the term structure for maturities
of 1 to 5 years for the following paths of one year interest rates
over the next five years. Explain for each what the yield curve
would look like.
3% 4% 5% 6% 7%
3% 2% 1% 1% 2%

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...

Using the pure expectations theory of the term structure and the
associated equation for the 10 yr GS, explain what forward guidance
means and how the use of it is supposed to influence the
economy.

Assuming that the Market Expectations
theory is the correct theory of the term structure, calculate the
interest rates in the term structure for maturities of one to five
years, for the following series of one –year interest rates;
a. 5%, 7%, 7%,7%,7%
b. 5%, 4%, 4%, 4%, 4%

If the pure expectations theory of the term structure is
correct, which of the following statements is CORRECT?
A. An upward sloping yield curve would imply that interest rates
are expected to be lower in the future.
B. If a 1-year Treasury bill has a yield to maturity of 7% and a
2-year Treasury bill has a yield to maturity of 8%, this would
imply the market believes that 1-year rates will be 7.5% one year
from now.
C. The...

Explain the Expectation Theory of the term structure of interest
rates

Using the expectations hypothesis theory for the term structure
of interest rates, determine the expected return for securities
with maturities of two, three, and four years based on the data. Do
an analysis similar to that in the right-hand portion of Table 6-6.
1-year of T-bill at beginning of year 1.....5% 1-year of T-bill at
beginning of year 2.....8% 2-year of T-bill at beginning of year
3.....7% 3-year of T-bill at beginning of year 4.....10%

Using the expectations hypothesis theory for the term structure
of interest rates, determine the expected return for securities
with maturities of two, three, and four years based on the
following data. (Input your answers as a percent rounded to
2 decimal places.)
Interest Rate
1-year T-bill at beginning of year 1
4
%
1-year T-bill at beginning of year 2
6
%
1-year T-bill at beginning of year 3
7
%
1-year T-bill at beginning of year 4
9...

The _ theory purposes the term structure of interest
rates is determined solely by the demand for and supply of
securities hacking a specific maturity

Suppose that the expectations hypothesis holds and that the
current term structure of interest rates is as follows:
• y1 = 5%
• y2 = 6%
• y3 = 7%
a. What is the expected value of the two-year spot rate
realizing at year one, E(1y3)?
b. What is the expected price of a two-year zero-coupon bond
with a face value of $100 trading at year one?

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