Used to estimate future short-term interest rates

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Pure expectations theory

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.

A.True

B.False

The yield on a one-year Treasury security is 5.3800%, and the two-year Treasury security has a 6.4560% 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?

A. 7.5400%

B. 6.4090%

C. 9.5758%

D. 8.5956%

Recall that on a one-year Treasury security the yield is 5.3800% and 6.4560% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0.2500%. What is the market’s estimate of the one-year Treasury rate one year from now?

A. 8.9535%

B. 5.9925%

C. 8.0370%

D. 7.0500%

Suppose the yield on a two-year Treasury security is 5.83%, and the yield on a five-year Treasury security is 6.20%. Assuming that the pure expectations theory is correct, what is the market’s estimate of the three-year Treasury rate two years from now?

A. 6.45%

B. 6.69%

C. 6.53%

D. 5.46%

Reference no: EM131568912

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