Using the Information Provided and the Expectations Hypothesis, Compute the Yields

question 111

Essay

Using the information provided and the expectations hypothesis, compute the yields for a two-year, three-year, and four-year bonds.

Now, suppose there is a risk premium attached to each bond. These risk premiums are given in the table below:

Using the information above and the liquidity premium theory, compute the yields for a two- year, three-year, and four-year bonds. How does this yield curve compare to the one you computed using the expectations hypothesis?

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Definitions:

Rate of Return

Rate of return is the gain or loss on an investment over a specified period, expressed as a percentage of the investment's initial cost.

Dividend Remains

Indicates the portion of earnings that a company decides to retain rather than distribute to shareholders as dividends.

Annual Dividend

The total dividend payment a shareholder receives from a company in a single year.

Market Rate of Return

The average rate of return that investors expect to earn in the financial markets from an investment, reflecting the risk compared to the risk-free rate.