Question

The pure expectations theory, or the expectations hypothesis, 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?

1. The pure expectations theory assumes that investors do not consider long-term bonds to be riskier than short-term bonds.

True

False

2. The yield on a one-year Treasury security is 5.1500%, and the two-year Treasury security has a 6.9525% 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? (Note: Do not round your intermediate calculations.)

10.0159%

11.1581%

8.7859%

7.468%

3. Recall that on a one-year Treasury security the yield is 5.1500% and 6.9525% 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 0.45%. What is the market’s estimate of the one-year Treasury rate one year from now? (Note: Do not round your intermediate calculations.)

8.9745%

7.8724%

9.9979%

6.6915%

4. Suppose the yield on a two-year Treasury security is 5.83%, and the yield on a five-year Treasury security is 6.20%. Assuming that the pure expectations theory is correct, what is the market’s estimate of the three-year Treasury rate two years from now? (Note: Do not round your intermediate calculations.)

6.45%

7.10%

6.69%

6.61%

Answer 1