a. Discuss how each of the following theories for the term structure of interest rates could explain an upward slope of the yield curve:
(1) Pure expectations (unbiased)
(2) Liquidity preference (term premium)
(3) Market segmentation
The following are the current coupon yields to maturity and spot rates of interest for six
U.S. Treasury securities. Assume all securities pay interest annually.
YIELDS TO MATURITY AND SPOT RATES OF INTEREST
|
Term to Maturity
|
Current Coupon Yield to Maturity
|
Spot Rate of Interest
|
|
1-year Treasury
|
5.25%
|
5.25%
|
|
2-year Treasury
|
5.75
|
5.79
|
|
3-year Treasury
|
6.15
|
6.19
|
|
5-year Treasury
|
6.45
|
6.51
|
|
10-year Treasury
|
6.95
|
7.10
|
|
30-year Treasury
|
7.25
|
7.67
|
b. Compute, under the pure expectations theory, the two-year implied forward rate three years from now, given the information provided in the preceding table. State the as- sumption underlying the calculation of the implied forward rate.