fnan The pure expectations theory, or the expectations hypothesis, asserts that

Question

fnan The pure expectations theory, or the expectations hypothesis, asserts that long-term interest rates can be used to estimate future short-term interest rates. Based on the pure expectations theory, is the following statement true or false? The pure expectations theory assumes that investors do not consider long-term bonds to be riskier than short-term bonds. The yield on a one-year Treasury security is 4.2300%, and the two-year Treasury security has a 5.0800% yield. Assuming that the pure expectations theory is correct, what is the market's estimate of the one-year Treasury rate one year from now?

Explanation / Answer

1. Correct answer is True

2. Correct answer is Option D i.e. 5.9400%

Yield on 2 year security excluding maturity risk premium = 5.08%

1f1 = ((1.0508)^2 / (1.0423) ) - 1

= 1.05937 - 1

= 0.59369 or 5.94%

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