Question

1.Empirical evidence shows that the implied forward rates derived from a spot rate curve based on the pure expectations theory are

A.upward-biased predictors of future spot rates

B.unbiased predictors of future spot rates

C.downward biased predictors of future spot rates

2. Empirical evidence suggests that historically, short-term spot rates on average are higher relative to long-term spot rates most of the time.

True

False

3. When the spot rate curve is upward sloping, the implied forward rate:

A.is above the spot rate of the same maturity

B. coincides with the spot rate of the same maturity

C. is below the spot rate of the same maturity

Answer 1

Q1) B) Unbiased predictor of future spot rates.

Explanation: as per pure expectation theory expected future spot rates of interest are equal to the forward rates that can be calculated today (from observed spot rates). In other words, the forward rates are unbiased predictors for making expectations of future spot rates.

Q2) False

Explanation: As in the long term risk is more, the rates would also be higher to compensate for it. So the short term spot rates should be less than long term spot rates.

Q3) A) Is above the spot rate of the same maturity

Explanation: When the spot curve is upward sloping, the forward curve will be lie above the spot curve and will also be upward sloping with a steeper slope. When the spot curve is flat, forward rates will equal spot rates and yields. When the spot curve is downward sloping, forward rate curves will be below the spot curve and the yield for a maturity greater than the spot rate ST.