Suppose the yield to maturity on a one-year zero-coupon
Question # 00464510
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Updated on: 01/17/2017 03:31 AM Due on: 01/17/2017
7. Suppose the yield to maturity on a one-year zero-coupon bond is 8%. The yield to matu-
rity on a two-year zero-coupon bond is 10%. Answer the following questions (use annual
compounding):
(a) According to the Expectations Hypothesis, what is the expected one-year rate in the
marketplace for year 2?
(b) Consider a one-year investor who expects the yield to maturity on a one-year bond to
equal 6% next year. How should this investor arrange his or her portfolio today?
(c) If all investors behave like the investor in (b), what will happen to the equilibrium term
structure according to the Expectations Hypothesis?
rity on a two-year zero-coupon bond is 10%. Answer the following questions (use annual
compounding):
(a) According to the Expectations Hypothesis, what is the expected one-year rate in the
marketplace for year 2?
(b) Consider a one-year investor who expects the yield to maturity on a one-year bond to
equal 6% next year. How should this investor arrange his or her portfolio today?
(c) If all investors behave like the investor in (b), what will happen to the equilibrium term
structure according to the Expectations Hypothesis?
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Solution: Suppose the yield to maturity on a one-year zero-coupon