Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year
ID: 2670832 • Letter: A
Question
Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT? A. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%. B. The interest rate today on a 2-year bond should be approximately 6%. C. The interest rate today on a 2-year bond should be approximately 7%. D. The interest rate today on a 3-year bond should be approximately 7%. E. The interest rate today on a 3-year bond should be approximately 8%. I know the answer is D but how do you get that answer step wise? I know the answer isExplanation / Answer
Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?
A. The yield curve should be downward sloping, with the rate on a 1-year bond at 6
B. The interest rate today on a 2-year bond should be approximately 6%.
C. The interest rate today on a 2-year bond should be approximately 7%.
D. The interest rate today on a 3-year bond should be approximately 7%.
E. The interest rate today on a 3-year bond should be approximately 8%.
6% +7% +8%= 7%.
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