The pure expectations theory, or the expectations hypothess, asserts that long-t

Question

The pure expectations theory, or the expectations hypothess, asserts that long-term interest rates can be used to estimate future short-term interest rates. Based on the pure expectations theory, is the folowing statement true or false? The pure expectations theory assumes that investors do not consider long-term bonds to be riskier than short-term bonds O True O False The yield on a one-year Treasury security is 4.2300%, and the two-year Treasury Assuming that the pure expectations theory is correct, what is one year from now? security has a 5.7100% yield. the market's estimate of the one-year Treasury rate 6.1370% 9.1694% ® 7.2200% 82308% Recall that on a one-year Treasury security the yield is 4.2300% and S.7100% on a two-year Treasury secunty. Suppose the one-year secunty does not have a matunty risk premlum, but the two-year security does and it is 0.2500%, what is the market's estimate of the one-year Treasury rate one year from now? 8.5220% 57040% 9 6.7100% 9 7 6400% reasury security is 6.20%. 2 3 4

Explanation / Answer

1.
True
2.
=(1+rate for 2 year)^2/(1+rate for 1 year)-1
=(1+5.71%)^2/(1+4.23%)-1
=7.2200%
3.
=(1+5.71%-0.25%)^2/(1+4.23%)-1
=6.7100%
4.
=((1+rate for 5 year)^5/(1+rate for 2 years)^2)^(1/3)-1
=((1+6.2%)^5/(1+5.83%)^2)^(1/3)-1
=6.45%

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