1) Assuming that the expectations theory is the correct one of the term structur

Question

1) Assuming that the expectations theory is the correct one of the term structure, calculate the interest rates (%) in the term structure for maturities one to six years: (a) 4%, 4%, 5%, 6%, 6%, 6 (b) 5%, 5%, 4%, 4%, 4%, 4%, Explain what is happening to yield curve.

2) Refer to the 1). Assume that instead of the expectations theory, the liquidity premium theory takes place. What will be your answer to parts (a) and (b), if the following liquidity premiums are expected? 0%; 0.25%, 0.5%, 0.75%, 1%, and 1.25% respectively

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Explanation / Answer

They Yield to maturity will be a) 4% for a one-year bond , 4% for a two-year bond, 5% for a three- year bond, 6% for a four-year bond, 6% for a five-year bond and 6% for a six-year bond.

b) 5% for a one-year bond, 5% for a two-year bond, 4% for a three-year bond,4% for a four-year bond, 4% for a five-year bond and 4% for a six-year bond.

Yield curve will be a) upward sloping , b) downward sloping

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