Explore BrainMass
Share

Explore BrainMass

    Expected Rate of Interest: expectations theory

    This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

    Suppose the annual yield on a 2-year Treasury bond is 7.5 percent, the yield on a 1-year bond is 5 percent, k* is 3 percent, and the maturity risk premium is zero.

    A) Using the expectations theory, forecast the interest rate on a 1-year bond during the second year (Under the expectations theory, the yield on a 2-year bond is equal to the average yield on 1-year bonds in Year 1 and Year 2)

    B) What is the expected inflation rate in Year 1? Year 2?

    © BrainMass Inc. brainmass.com October 9, 2019, 7:17 pm ad1c9bdddf
    https://brainmass.com/business/interest-rates/expected-rate-of-interest-expectations-theory-113208

    Solution Preview

    Suppose the annual yield on a 2-year Treasury bond is 7.5 percent, the yield on a 1-year bond is 5 percent, k* is 3 percent, and the maturity risk premium is zero.

    A) Using the expectations theory, forecast the interest rate on a 1-year bond during the second year (Under the expectations theory, the yield on a 2-year bond is equal to the average yield on 1-year bonds in Year 1 ...

    Solution Summary

    The solution forecasts the interest rate on a 1-year bond during the second year using the expectations theory and calculates the expected inflation rate.

    $2.19