Assume that the expectations theory fully explains the Treasury Bond Yield Curve. The 10-year zero-coupon bond maturing in 2031 has a yield-to-maturity (YTM) of 4%.

Assume that instead of simply buying the 10 year, you decide you will:

buy a 5-year bond today, then, when that bond matures in 2026,

then, you will buy a new 5-year bond that starts in 2026 and will mature in 2031.

Scenario A Upward sloping yield curve. a) if todays 5 year bond has a YTM of 1%, what would the second bonds YTM need to be for you to get a terminal value that would match simply buying the 10 year bond today?

Scenario B Downward sloping yield curve b) if todays 5 year bond has a YTM of 5%, what would the second bonds YTM need to be for you to get a terminal value that would match simply buying the 10 year bond today?

Bond investors love bad news and dropping interest rates are usually a sign of economic weakness or even recessions. c) Which scenario indicates the bond market foresees a bad economy (A or B)?

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