3. Pure expectations theory: Two-year bonds

Which of the following is consistent with the pure expectations theory of the yield curve? Check all that apply.

A flat yield curve suggests that the market thinks interest rates in the future will be the same as they are today.

A downward-sloping yield curve suggests that the market thinks interest rates in the future will be higher than they are today.

A flat yield curve suggests that the market thinks interest rates in the future will be lower than they are today.

A downward-sloping yield curve suggests that the market thinks interest rates in the future will be lower than they are today.

Rajiv would like to invest a certain amount of money for two years and considers investing in a one-year bond that pays 6 percent and a two-year bond that pays 9 percent. Rajiv is considering the following investment strategies:

	Strategy A: In the first year, buy a one-year bond that pays 6 percent. Once that bond matures, buy another one-year bond that pays the forward rate.
	Strategy B: In the first year, buy a two-year bond that pays 9 percent annually.

If the one-year bond purchased in year two pays 7 percent, Rajiv will choose .

Which of the following describes conditions under which Rajiv would be indifferent between Strategy A and Strategy B?

The rate on the one-year bond purchased in year two pays 10.272 percent.

The rate on the one-year bond purchased in year two pays 11.360 percent.

The rate on the one-year bond purchased in year two pays 12.085 percent.

The rate on the one-year bond purchased in year two pays 13.052 percent.