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Using the Market Segmentation Theory, outline the impacts on the term structure of interest rates of the following cases: Economic Recession Economic Expansion Expansionary open
- Using the Market Segmentation Theory, outline the impacts on the term structure of interest rates of the following cases:
- Economic Recession
- Economic Expansion
- Expansionary open market operation in which the Central Bank buys S-T Treasuries.
- Treasury sale of long-term Treasury bonds.
- Treasury purchase of long-term Treasury bonds
- Explain Expectations Theory intuitively and with an example. In your example assume a flat yield curve with one- and two-year bonds at 6% and an expectation of next year's yield curve being flat with one- and two-year bonds at 8%. Explain the theory only in terms of the response to the expectation by investors with one-year and two-year horizon dates.
- Given the following spot yield curve:
Maturity | YTM |
1 Year 2 Years 3 Years 4 Years | 6.0% 6.5% 7.0% 7.5% |
- What is the equilibrium price of a four-year, 7% annual coupon bond paying a principal of $100 at maturity?
- Using implied forward rates estimate the yield curve one year from the present (1-year, 2-year, and 3-year spot rates).
- What is the expected equilibrium price one year from now of a three-year, 7% annual coupon bond paying a principal of $100 at maturity?
- What is the one-year expected rate of return from investing in the four-year, 7% coupon bond if your expectations were based on implied forward rates?
- Using implied forward rates estimate the yields for 1-year and 2-year spot rate two years from now.
- Show that the expected rate from holding the four-year, 7% coupon bond for two years is equal to the 2-year spot rate of 6.5%.
- Using the theories of term structure of interest rates identify several scenarios that would have a tendency of causing the yield curve to become negatively sloped.
- Explain the Liquidity Premium Theory.
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