1)The Interest on a One-Year Bond Today Is 3%;

question 97

Essay

1)The interest on a one-year bond today is 3%;
2)The interest on a one-year bond starting one year from now is expected to be 4% per year;
3)The interest on a one-year bond starting two years from now is expected to be 5% per year;
4)The risk premium on a two-year bond is 0.5%; and
5)The risk premium on a three-year bond is 1.0%.
Use that information to answer the following questions.
a)According to the expectations theory,what is the interest rate today on a two-year bond? Show your work.
b)According to the expectations theory,what is the interest rate today on a three-year bond? Show your work.
c)Plot the yield curve.

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Definitions:

Hypotheses

Proposed explanations for a phenomenon, meant to be tested through experimentation or observation.

Instruments

Tools or devices designed for a specific purpose, especially scientific or musical.

Independent Variable

The factor in a controlled experiment that is being manipulated.

Experimenter

A person who conducts scientific tests and trials to explore hypotheses and examine the effects of variables.