1.The yield of a one-year bond this year equals to 6.5%, and people expect the yield...

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1.The yield of a one-year bond thisyear equals to 6.5%, and people expect the yield of a one-year bondto remain the same on the second year but fall to 5% on the thirdyear. Also, people also require a 0.25% term premium for eachadditional year of bond maturity.
a.Calculate the yield of a two-yearbond and a three-year bond according to the theory of liquiditypremium. Compare the yields of the three-year bond, two-year bond,and one-year bond, what does it tell you about the shape of theyield curve? (10 points)
b.Calculate the yield of a two-yearbond and a three-year bond according to the expectations theory.Compare the yields of the three-year bond, two-year bond, andone-year bond, what does it tell you about the shape of the yieldcurve? (10 points)

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4.2 Ratings (545 Votes)

a Calculation of the bond according to liquidity premium theory 2 year bond 65652025 675 3 year bond 65502025 600 The yield curve is upward sloping when compared to 1st year 65 and See Answer

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1.The yield of a one-year bond thisyear equals to 6.5%, and people expect the yield of a one-year bondto remain the same on the second year but fall to 5% on the thirdyear. Also, people also require a 0.25% term premium for eachadditional year of bond maturity.a.Calculate the yield of a two-yearbond and a three-year bond according to the theory of liquiditypremium. Compare the yields of the three-year bond, two-year bond,and one-year bond, what does it tell you about the shape of theyield curve? (10 points)b.Calculate the yield of a two-yearbond and a three-year bond according to the expectations theory.Compare the yields of the three-year bond, two-year bond, andone-year bond, what does it tell you about the shape of the yieldcurve? (10 points)