Question

Explain each of the following in one to three sentences.

1. Assume that there is a sudden expectation of lower interest rates in the future. What would be the effect on the yield curve and why?

2. Name and explain the two components of the risk-free rate of return.

3. Explain what is meant by the Expectations Theory of Interest rate Determination.

Answer #1

1. if there is an expectation of lower interest rates in near future that will mean that yield curve will be sloping downwards because the short term Bond yields will not be going down much but the long term bond is will start to go down and that may cause an inverted yield curve

2. Two component of risk free return would be

A. Security by the government as they are highly secured instruments and they are backed by government

B. They have very low probability of default as they have a high security attached to them

3. Expectation theory focuses that there would always be expectation of investment into short term bonds because it will be lesser risky, so there would be an expectation of risk premium into investment into long term bonds as their more risky

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...

Assume that inflation is expected to decline steadily in the
future, but that the real risk rate will remain constant. which of
the following statements is correct.
1. if inflation is expected to decline, there can be no maturity
risk premium
2. the expectations theory cannot hold if inflation is
decreasing
3. if the pure expectations theory holds, the corporate yield
curve must be downward sloping
4. if the pure expectations theory holds, the treasury yield
curve must be downward...

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...

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...

One-year government bonds yield 6.9 percent and 3-year
government bonds yield 3.8 percent.
Assume that the expectations theory holds. What does
the market believe the rate on 2-year
government bonds will be one year from today?
2.05%
2.45%
2.35%
2.15%
2.25%
The real risk-free rate of interest is 3
percent. Inflation is expected to be 2 percent this
coming year, jump to 3 percent next year, and increase to 4
percent the year after (Year 3).
According to the expectations theory, what...

Section 1: True/False, & explain why in two or three
sentences:
3. Assume that you had estimated the following quadratic
regression model:
Test score = 607.3 + 3.85 Income - 0.0423
Income2. If income increased from 10 to 11
($10,000 to $11,000), then the predicted effect on testscores would
be 2.96.

Suppose that:
1) The interest rate on a one-year bond today is 3%;
2) The interest rate on a one-year bond starting one year from
now is expected to be 4% per year;
3) The interest rate on a one-year bond starting two years from
now is expected to be 5% per year;
4) The risk premium on a two-year bond is 0.5%; and
5) The risk premium on a three-year bond is 1%.
Use that information to answer the...

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 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...

Explain what is meant by the yield curve and briefly outline
three theories to explain unequal yields at different maturities
and how it is most often sloped. Then briefly explain why
Australia’s yield curve “inverted” during the boom years of
2006-2007.

Please explain why you think your answers are correct. Thank
you!
1. Preferred Habitat Theory states that investors and borrowers
always concentrate on a particular maturity market and never change
it. (True or False)
2. The relationship among interest rates on bonds with identical
default risk but different maturities is called the (liquidity
structure of interest rates, yield curve, physical money curve, or
time-risk structure of interest rates)
3. A firm's state of incorporation affects the yield on the debt...

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