1)According to the Expectations Theory of the yield curve, if the one year bond

Question

1)According to the Expectations Theory of the yield curve, if the one year bond rate today is .5%, the two year bond rate today is .6%, the three year bond rate today is .625% and the four year bond rate today is .63%, what is the expected one year bond rate three years from today? would you please provide some explanation as well?

2) If the top marginal income tax rate increases from 36% to 39.6%, and the supply of taxable bonds is perfectly elastic with an interest rate of 4.15%, find the equilibrium interest rate for Municipal bonds both before and after the change in tax rates. Did the equilibrium Municipal bond interest rate change? Why?

Explanation / Answer

(I2-I1)/(T2-T1) = -1

I2-4.15/3.6 = 1

I2 = 4.15+3.6 = .7.75%

Municipal bonds are generally exempted from federal and state taxes.

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