The pure expectations theory, or the expectations hypothes\'s, asserts that long
ID: 2811860 • Letter: T
Question
The pure expectations theory, or the expectations hypothes's, asserts that long-term interest rates can be used to estimate future short-term interest rates. Based on the pure expectations theory, is the following statement true or false? The pure expectations theory assurmes that a one-year bond purchased today will have the same return as a one-year bond purchased five years from now. O False O True The yield on a one-year Treasury security is 5.3800%, and the two-year Treasury security has a 64600% yield. Assuming that the pure expectations theory is correct, what is the market's estimate of the one-year Treasury rate one year from now? 64179% 75500% 8.6070% O 9,5885% Recall that on a one-year Treasury security the yield is S3800% and 6.4600% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0.4500%. what is the market's estimate of the one year Treasury rate one year trom non 9 7.5700% 8.4330% Q 5.6440% 66400% Suppose the yield on a two-year Treasury security is 5.83%, and the yield on anveyear Treasury that the pure expectations theory is correct, what is the market's estimate of the three-year Treasury rate starty e2 2 3 4 6Explanation / Answer
1) The pure expectations theory assumes that a one-year bond purchased today will have the same return as a one-Year bond purchased five years from now. FALSE The pure expectations theory assumes that the two-year yield is equal to a one-year bond today plus the expected return on a one-year bond purchased one year from today. 2) One year treasury Security yield = R1 5.38% Two year Treasury seecurity yield = R2 6.46% Rate (1, 2) = [(1+ two year rate) ^2 / (1+ one year rate) ^1 -1]*100 Rate (1, 2) = [(1.0646) ^2/ (1.0538) -1]*100 7.5511% 3) One year treasury Security yield = R1 5.38% Expected return on 2-year series = Rate on 2 - year bond MRP = 6.46% -.4500% 6.01% Rate (1, 2) = [(1+ two year rate) ^2 / (1+ one year rate) ^1 -1]*100 Rate (1, 2) = [(1.0601) ^2/ (1.0538) -1]*100 6.644%
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