Question
The current yield curve is inverted. Specifically, the current one-year interest rate is 1 R 1 = 5%, and the yields of two- and three-year
The current yield curve is inverted. Specifically, the current one-year interest rate is 1R1 = 5%, and the yields of two- and three-year bonds are 1R2 = 4.5% and 1R3 = 4%, respectively. Suppose unbiased expectations hypothesis is true.
1.Please solve for the market expectations of the one-year interest rates for next year and the year after (E(2r1) and E(3r1), respectively).
2.Suppose market expectation of the one-year interest rate two years later (E(3r1)) suddenly increased. Nothing else changed. What will happen to the yields of two-year bonds 1R2?
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