Question

Consider two $1000 par treasury bonds that are zero-coupon: (i) a 1-year bond with a yield to maturity of 2%; (ii) a 2-year bond with a yield to maturity of 4%.

The yield curve is??:

A) Upward sloping

B) Downward sloping

C) Flat

What is the 1-year forward rate (f1,2) based on the expectations model? In other words, what is the expected 1-year rate starting in one year from now and going one year? (to the nearest whole percent)

A) 2%

B) 3%

C) 4%

D) 6%

Answer 1

1)

Correct answer: A) Upward sloping

Yield curve shows the relationship between yield rate (market interest rate) and years until maturity. A yield curve is upward sloping when interest rate increases as matuturity of bond increases.

2)

Correct answer: D) 6%

Yield rate Year-1 = 2%

Yield rate Year-2 = 4%

Thus,