5. Assume the following interest rates Current Rate on a 1-year bond due in 2019: 4% Expected...

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5. Assume the following interest rates
Current Rate on a 1-year bond due in 2019: 4%
Expected Rate on a 1-year bond due in 2020: 5%
Expected Rate on a 1-year bond due in 2021: 6%
Expected Rate on a 1-year bond due in 2022: 4%
Expected Rate on a 1-year bond due in 2023: 2%
a. According to the expectations theory for the yield curve,what would be the current rate on a 3-year bond due in 2021? Showwork.
b. According to the expectations theory for the yield curve,what would be the current rate on a 5-year bond due in 2023? Showwork.
c. Graph and explain the yield curve. Explain how and why itmight be upward sloping and when it might be downward sloping.Explain.
d. How might the liquidity preference theory change yourresults? Explain.
e. How might risk premiums change your results? Explain.
Could you answer e?

Answer & Explanation Solved by verified expert

3.7 Ratings (630 Votes)

The question relates with derivation of yield curve using spot rates and forward rates The timeline in the question is as follows 1 2 3 4 5 2019 2020 2021 2022 2023 S01 4 F12 5 F23 6 F34 4 F45 2 Current rate on 1year bond due in 2019 spot rate for 1 year S01 4 Expected rate on 1year bond due in 2020 forward rate for 1 year after 1 year F12 5 F21 is read as 1 year forward rate 2 years from today Expected rate on 1year bond due in 2021 forward rate for 1 year after 2 years F23 6 F23 is read as 1 year forward rate 3 years from today Expected rate on 1year bond due in 2022 forward rate for 1 year after 3 years F34 4 F34 is read as 1 year forward rate 4 years from today Expected rate on 1year bond due in 2023 forward rate for 1 year after 4 years F45 2 F45 See Answer

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5. Assume the following interest ratesCurrent Rate on a 1-year bond due in 2019: 4%Expected Rate on a 1-year bond due in 2020: 5%Expected Rate on a 1-year bond due in 2021: 6%Expected Rate on a 1-year bond due in 2022: 4%Expected Rate on a 1-year bond due in 2023: 2%a. According to the expectations theory for the yield curve,what would be the current rate on a 3-year bond due in 2021? Showwork.b. According to the expectations theory for the yield curve,what would be the current rate on a 5-year bond due in 2023? Showwork.c. Graph and explain the yield curve. Explain how and why itmight be upward sloping and when it might be downward sloping.Explain.d. How might the liquidity preference theory change yourresults? Explain.e. How might risk premiums change your results? Explain.Could you answer e?