Assignment 06-Interest Rates Due on Tomorrow at 1 1 :59 PM PST 8. Pure expectati
ID: 2806093 • Letter: A
Question
Assignment 06-Interest Rates Due on Tomorrow at 1 1 :59 PM PST 8. Pure expectations theory Aa Aa 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? A certificate of deposit (CD) for two years will have the same yield as a CD for one year followed by an investment in another one-year CD after one year. True O False The yield on a one-year Treasury security is 5.3800%, and the two-year Treasury security has a 6.4600% 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? 6.4175% O 8.607096 O 7.5500% O 9.5885%Explanation / Answer
True since the expectations will be formed based on the reinvestment of funds into 1 year CoDs that the 2 year CoDs will be priced similarly.
(1+r) =(1+6.46%)2/(1+5.38%) IMPLIES r equals 7.55%
(1+r) =(1+6.46%+.25%)2/(1+5.38%) implies r equals 8.0%
(1+r)3=(1+6.2%)5/(1+5.83%)2 imples r equals 6.45%