Assume That the Rate on a 1-Year Bond Is Now

question 52

Multiple Choice

Assume that the rate on a 1-year bond is now 6%,but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now.Assume also that the pure expectations theory holds,hence the maturity risk premium equals zero.Which of the following statements is CORRECT?

• A) The yield curve should be downward sloping,with the rate on a 1-year bond at 6%.
• B) The interest rate today on a 2-year bond should be approximately 6%.
• C) The interest rate today on a 2-year bond should be approximately 7%.
• D) The interest rate today on a 3-year bond should be approximately 7%.
• E) The interest rate today on a 3-year bond should be approximately 8%.

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Definitions:

Opening Balance Equity

An account used in accounting to balance the books when starting a new company file or reconciling accounts.

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