The pure expectations theory, or the expectations hypothesis,asserts that long-term interest rates can be used to estimatefuture short-term interest rates.

Based on the pure expectations theory, is the followingstatement true or false?

The pure expectations theory assumes that a one-year bondpurchased today will have the same return as a one-year bondpurchased five years from now.

False

True

The yield on a one-year Treasury security is 4.2300%, and thetwo-year Treasury security has a 5.7105% yield. Assuming that thepure expectations theory is correct, what is the market’s estimateof the one-year Treasury rate one year from now? (Note: Do notround your intermediate calculations.)

7.212%

6.1302%

8.2217%

9.1592%

Recall that on a one-year Treasury security the yield is 4.2300%and 5.7105% on a two-year Treasury security. Suppose the one-yearsecurity does not have a maturity risk premium, but the two-yearsecurity does and it is 0.15%. What is the market’s estimate of theone-year Treasury rate one year from now? (Note: Do not round yourintermediate calculations.)

7.8751%

6.908%

5.8718%

8.7732%

Suppose the yield on a two-year Treasury security is 5.83%, andthe yield on a five-year Treasury security is 6.20%. Assuming thatthe pure expectations theory is correct, what is the market’sestimate of the three-year Treasury rate two years from now? (Note:Do not round your intermediate calculations.)

6.61%

6.53%

7.10%

6.45%