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11. S: Interest Rates: Using the Yield Curve to Estimate Future Interest Rates You can calculate the yield curve, given inflation and maturity-related risks. Looking

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11. S: Interest Rates: Using the Yield Curve to Estimate Future Interest Rates You can calculate the yield curve, given inflation and maturity-related risks. Looking at the yield curve, you can use the information embecded in it to estimate the market's expectations regarding future inflation, risk, and short-term interest rates. The theory states that the shape of the yield curve depends on investors' expectations about future interest rates. The theory assumes that bond traders establish bond prices and interest rates strictly on the basis of expectations for future interest rates and that they are indilferent to maturity ause they don't v ew long-term bonds as being risker than short-term bonds. For example, assume that you had1-year T bond nat yiele 12% an. 2rnar r bond that yed From this information you could determine what the yield on a 1-year T-bond one year from now would be. Investors with a 2-year horizon could invest in the 2-year T-bond or they could invest in 1-year T-bond ay and a 1 year T-bond one year from today. Both options should yield the same resuit the market is in equilib um; otherwise, investors would buy and sei securities until the market was in equilibrium Quantitative Problem Today, Interest rates on 1-year T-bonds weld 1.2%, interest rates on 2-year T-bonds yield 2 6%, and interest rates on 3-year T-bonds yield 3.6%. aIf the pure expectations theory is correct, what is the yield on 1-year T-bonds one year from now? Be sure to use a geometnc average in your cakulations. Round your answer to fur decimal places. Do not round intermediate calculations b. If the pure expectations theory rrect, what is the yeld on 2-year T-bonds one year from now? Be sure to use a geometric average in your calculations Round your answer to tur decimal places. Do not round intermediate caculations. c. If the pure expectations theory is correct, what is the yield on 1-year T-bands two years from now? Be sure to use a geometric average in your caiouations Round your answer to four decimal places. Do not round intermediate calculations

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