In: Finance
3. Pure expectations theory: Two-year bonds
Which of the following is consistent with the pure expectations theory of the yield curve? Check all that apply.
A flat yield curve suggests that the market thinks interest rates in the future will be the same as they are today.
A downward-sloping yield curve suggests that the market thinks interest rates in the future will be lower than they are today.
A flat yield curve suggests that the market thinks interest rates in the future will be higher than they are today.
A downward-sloping yield curve suggests that the market thinks interest rates in the future will be higher than they are today.
Brian would like to invest a certain amount of money for two years and considers investing in a one-year bond that pays 3 percent and a two-year bond that pays 7 percent. Brian is considering the following investment strategies:
Strategy A: Buy a one-year bond that pays 3 percent and in year one, buy another one-year bond that pays the forward rate in year two. | |
Strategy B: Buy a two-year bond, in year one, that pays 7 percent in the first year and 7 percent in the second year. |
If the one-year bond purchased in year two pays 7 percent, Brian will choose (STRATEGY A OR B)
.
Which of the following describes conditions under which Brian would be indifferent between Strategy A and Strategy B?
The rate on the one-year bond purchased in year two pays 11.155 percent.
The rate on the one-year bond purchased in year two pays 11.601 percent.
The rate on the one-year bond purchased in year two pays 12.047 percent.
The rate on the one-year bond purchased in year two pays 9.482 percent.
Which of the following is consistent with the pure expectations theory of the yield curve? Check all that apply.
Option B is correct A downward-sloping yield curve suggests that the market thinks interest rates in the future will be lower than they are today.
Option C is correct. A flat yield curve suggests that the market thinks interest rates in the future will be higher than they are today.
Brian would like to invest a certain amount of money for two years and considers investing in a one-year bond that pays 3 percent and a two-year bond that pays 7 percent. Brian is considering the following investment strategies:
Future value of strategy A = Investment * (1 + Interest)^Years = 1000 * 1.03^2 = $1061
Future value of strategy B = Investment + 2 * Investment * Interest rate + Coupon in year 1 * Interest rate = 1000 + 1000*2*7% + 1000*7%*7%= $1144.9
Strategy B is recommended as its future value is higher
Which of the following describes conditions under which Brian would be indifferent between Strategy A and Strategy B?
(1 + 1 year bond Interest)*(1 + second year interest) = Future value of 2 year bond / investment
(1 + 0.03)*(1 + second year interest) = 1144.90 / 1000
1.03 * (1 + second year interest) = 1.1449
(1 + second year interest) = 1.11155
second year interest = 11.155%
The rate on the one-year bond purchased in year two pays 11.155 percent.