a. The maturity risk premium is positive. b. Interest rates are expected to rise

Question

a.

The maturity risk premium is positive.

b.

Interest rates are expected to rise over the next two years.

c.

The market expects one-year rates to be 5.5% one year from today.

d.

Answers a, b, and c are all correct.

e. Only answers b and c are correct.   

And please explain why            

a.

The maturity risk premium is positive.

b.

Interest rates are expected to rise over the next two years.

c.

The market expects one-year rates to be 5.5% one year from today.

d.

Answers a, b, and c are all correct.

e. Only answers b and c are correct.   

And please explain why            

Explanation / Answer

Hi,

Option (E), "Only answers b and c are correct" is the correct answer

Explanation: The hypothesis that long-term interest rates contain a prediction of future short-term interest rates. Expectations theory postulates that you would earn the same amount of interest by investing in a one-year bond today and rolling that investment into a new one-year bond a year later compared to buying a two-year bond today

Also,  If the expectations theory holds, the Treasury yield curve must be downward sloping. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping. Since the yield curve must be downward sloping, the maturity risk premium is not positive

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