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Suppose the pure expectations theory of the term structure is correct. You can buy a 2-year...

Suppose the pure expectations theory of the term structure is correct. You can buy a 2-year discount bond with face value of $1500 for $1360.54. You plan to sell it next year for a price you expect will be $1456.31. a. what is the annual rate of return on 2-year bonds? Explain. b. What is the rate of return on 1-year discount bonds you expect? will it hold next year? explain. c. What is the rate of return on 1-year discount bonds today? why? d. Suppose that, contrary to what you found in part c., the current one-year rate was .04 (4%). Explain what forces would move it to the level you found in part c. (Hint: are there arbitrage opportunities?)

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Rahul Sunny answered 1 year ago
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