a. The maturity risk premium is positive. b. Interest rates are expected to rise
ID: 2630524 • Letter: A
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