Use this information to answer the next two questions. A 1 year zero coupon bond has a yield to maturity of 3%. A two year zero coupon bond has a yield to maturity of 4%.

Q1: If the Expectations Hypothesis is true, which of the following statements are true in this example. Check off all that apply.

The expected return from investing in the 2 year bond today and selling it after 1 year is equal to 3%.

The expected return from investing in the 2 year bond today and selling it after 1 year is equal to 4%.

The expected yield on a one year zero coupon bond one year from today is equal to 3%.

The expected yield on a one year zero coupon bond one year from today is equal to 4%.

The expected yield on a one year zero coupon bond one year from today is equal to 5%.

Q2: Assume that the Expectations Hypothesis is not true, and that in addition to expectations about future rates, the shape of the yield curve also includes term premiums to compensate for interest rate risk. In that case, which of the following statements are true for the example above. Choose all that apply.

The expected return from investing in the 2 year bond and selling is after 1 year is less than 3%.

The expected return from investing in the 2 year bond and selling is after 1 year exceeds 3%.

The expected one year interest rate in one year is less than the one year forward rate from year 1 to year 2.

The expected one year interest rate in one year equals the one year forward rate from year 1 to year 2.

The expected one year interest rate in one year exceeds the one year forward rate from year 1 to year 2.

Use this information to answer questions 3 and 4. Imagine that the economy is doing well and that economic growth is in line with the long run potential growth rate of the economy and that inflation is running close the Fed's preferred target. The Fed is currently happy with the stance of monetary policy and the market believes that the Fed is unlikely to change the Fed Funds target for the next 2 years. The current yield curve is modestly upward sloping with a normal shape. Suddenly a strong hurricane strikes the Northeast US causing widespread economic damage and market comes to believe that the Fed will react to limit the damage by cutting rates at its next policy meeting in 6 weeks.

Q3: Describe what you believe would happen to yields on US Treasuries on the day following the hurricane at these three maturity points on the yield curve: 1 month, 2 years, and 10 years . Pick only one answer.

Interest rates will fall by roughly the same amount at all 3 maturity points.

The one month yield will fall modestly, the 2 year yield will fall by a greater amount than the 1 month yield and the 10 year yield will fall by less than the 2 year yield.

All three yields will fall. The drop in the one month rate will be larger than the drop in the 2 year rate which in turn will be less than the drop in the 10 year rate.

Q4: When the Fed meets, it decides to cut rates by 0.50%, and it indicates that this will be the only rate cut needed in response to the hurricane impacts on the economy. What happens in the market when this is announced.

The 1 month rate falls by 0.50%, the 2 year falls by less than than the 1 month yield, and the 10 year yield falls by an even smaller amount.

All three yields fall by 0.50%.

The 1 month rate falls by less than 0.50%, the 2 year falls by less than than the 1 month yield, and the 10 year yield falls by an even smaller amount.