Microsoft Word - mid2-p2-005A.docx

1. Suppose you notice in todays newspaper that the yields available on 1-year, 3-year and 7-year government securities are 1 percent, 3 percent and 5 percent, respectively. According to the expectation hypothesis theory, what does the market believe that 2-year bond yield next year (R12014) and 4-year bond yield 3 years from now (R42016)? (you are asked to illustrate in detail how you get your answers using the concepts of B.H.S. and R.O.S.)