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Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates
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1. Assuming that the expectations theory is the correct theory of the term structure,
calculate the interest rates in the term structure for maturities of one to five years for the
following series of one-year interest rates over the next five years.
a. 5%, 7%, 7%, 7%, 7%
The yield to maturity for a 1 year bond would be 5%, 5.9953% for a 2 year bond,
6.3291% for a three-year bond, 6.4965% for a four year bond and 6.5970% for a
5-year bond
b. 5%, 4%, 4%, 4%, 4%
The yield to maturity would be 5% for a one-year bond, 4.5% for a two-year bond, 4%
for a three-year bond, 4% for a four-year bond, and 4.2% for a five-year bond.
2. Government economists have forecasted one-year T-bill rates for the following five
years as follows:
Year
1-year rate
1
4.25%
2
5.15%
3
5.50%
4
6.25%
5
7.10%
You have liquidity premium 0.25% for the next two years and 0.50% th...
