1. A certificate of deposit (CD) for 2 years willhave the same yield as a CD or
ID: 2731454 • Letter: 1
Question
1. A certificate of deposit (CD) for 2 years willhave the same yield as a CD or 1 year followed by an investment in another 1 year CD after 1 year.
TRUE or FALSE
2. Recall that a 1 year treasury security the yield is 4.9200% and 7.3800% on a 2 year treasury security. Suppose the 1 year security does not have a maturity risk premium, but the 2 year security does and it is 0.4000%. What is the markets estimate of the 1 year Treasury rate 1 year from now? A. 7.7180% B. 10.3510% C. 9.0800% D. 11.5320%
Explanation / Answer
1) A certificate of deposit (CD) for 2 years shall have the same yield as the 1 year CD roll over to another 1 year CD due to arbitrage. If the yield were not the same some arbitrageurs would have capitalize on it and make a risk less profit.Therefore the yield shall be the same due to the arbitrage.Hence TRUE.
2) (1+1 year treasury security yield)*(1+1 year from now treasury security yield)=(1+2 year treasury security yield-maturity premium)^2
(1+.0492)*(1+1 year from now treasury security yield)=(1+.0738-.004)^2=1.0698^2
1+1 year from now treasury security yield=1.0698^2/1.0492=1.09080
=> 1 year from now treasury security yield=1.09080-1=0.09080=9.08% option C).
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.