6. Pure expectations theory

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

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

The pure expectations theory assumes that investors do not consider long-term bonds to be riskier than short-term bonds.

True

False

The yield on a one-year Treasury security is 5.1500%, and the two-year Treasury security has a 6.1800% yield. Assuming that the pure expectations theory is correct, what is the markets estimate of the one-year Treasury rate one year from now? (Note: Do not round your intermediate calculations.)

7.2201%

6.1371%

9.1695%

8.2309%

Recall that on a one-year Treasury security the yield is 5.1500% and 6.1800% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0.2%. What is the markets estimate of the one-year Treasury rate one year from now? (Note: Do not round your intermediate calculations.)

7.7708%

6.8165%

5.794%

8.657%

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

7.10%

6.61%

6.45%

5.46%