Question 2 (2 mark) Consider the term structure of interest rates on bonds of length 1, 2, 3, 4, and 5 years. a. Suppose the current and future one year interest rates are 2.5%; that is in1 = 112 = 113 = 114 = 11.5 = 2.5. Calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curves for bonds maturing in years 1-5, assuming the expectations hypothesis is correct (i.e. no risk premium). Yield term b. No assume because of interest rate risk longer term bonds have a higher risk premium, which we call ke, where the subscript is the time until the bond matures. Now assume k, = 0.25, kg = 0.5, k, = 0.75, and ks = 1.0 c. Again, calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curve again for bonds maturing in years 1-5. term d. Does the yield curve explain why yield curves usually are upward sloping? yield curves are only upward sloping if one expects the short-term interest rates to rise in the future. Another answer: A yield curve is typically upward sloping as the time to maturity increases, so does the associated interest rate. The reason for that is that debt issued for a longer term generally carries greater risk because of the greater likelihood of inflation or default in the long run. e. What would it take for the yield curve to be downward sloping? Question 2 (2 mark) Consider the term structure of interest rates on bonds of length 1, 2, 3, 4 and 5 years. 1 2. Suppose the current and future one year interest rates are 2.5%, that is in 12- 13 14 15 = 2.5. Calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curves for bonds maturing in years 1-5, assuming the expectations hypothesis is correct (.e. no risk premium) Yield + term b. No assume because of interest rate risk longer term bonds have a higher risk premium, which we call k, where the subscript is the time until the bond matures. Now assume k, = 0.25, ks = 0.5, k = 0.75, and ks = 1.0 c. Again, calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curve again for bonds maturing in years 1-5. 2 Yield term d. Does the yield curve explain why yield curves usually are upward sloping? yield curves are only upward sloping if one expects the short-term interest rates to rise in the future. Another answer: A yield curve is typically upward sloping as the time to maturity increases, so does the associated interest rate. The reason for that is that debt issued for a longer term generally carries greater risk because of the greater likelihood of inflation or default in the long run. e. What would it take for the yield curve to be downward sloping? Question 2 (2 mark) Consider the term structure of interest rates on bonds of length 1, 2, 3, 4, and 5 years. a. Suppose the current and future one year interest rates are 2.5%; that is in1 = 112 = 113 = 114 = 11.5 = 2.5. Calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curves for bonds maturing in years 1-5, assuming the expectations hypothesis is correct (i.e. no risk premium). Yield term b. No assume because of interest rate risk longer term bonds have a higher risk premium, which we call ke, where the subscript is the time until the bond matures. Now assume k, = 0.25, kg = 0.5, k, = 0.75, and ks = 1.0 c. Again, calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curve again for bonds maturing in years 1-5. term d. Does the yield curve explain why yield curves usually are upward sloping? yield curves are only upward sloping if one expects the short-term interest rates to rise in the future. Another answer: A yield curve is typically upward sloping as the time to maturity increases, so does the associated interest rate. The reason for that is that debt issued for a longer term generally carries greater risk because of the greater likelihood of inflation or default in the long run. e. What would it take for the yield curve to be downward sloping? Question 2 (2 mark) Consider the term structure of interest rates on bonds of length 1, 2, 3, 4 and 5 years. 1 2. Suppose the current and future one year interest rates are 2.5%, that is in 12- 13 14 15 = 2.5. Calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curves for bonds maturing in years 1-5, assuming the expectations hypothesis is correct (.e. no risk premium) Yield + term b. No assume because of interest rate risk longer term bonds have a higher risk premium, which we call k, where the subscript is the time until the bond matures. Now assume k, = 0.25, ks = 0.5, k = 0.75, and ks = 1.0 c. Again, calculate the annual yield on bonds of 1, 2, 3, 4, and 5 years, and plot the yields on the graph below to draw the yield curve again for bonds maturing in years 1-5. 2 Yield term d. Does the yield curve explain why yield curves usually are upward sloping? yield curves are only upward sloping if one expects the short-term interest rates to rise in the future. Another answer: A yield curve is typically upward sloping as the time to maturity increases, so does the associated interest rate. The reason for that is that debt issued for a longer term generally carries greater risk because of the greater likelihood of inflation or default in the long run. e. What would it take for the yield curve to be downward sloping