“According to the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond if interest rates on one-year bonds are expected to be the same in both years.” Is this statement true, false, or uncertain?

Short Answer

Expert verified

Based on this definition, it is possible to conclude that the given statement is false.

Step by step solution

01

Definition

The expectation theory can be defined as the interest rate o a long-term bond will be equal to an average of the short-term interest rates that are expected to occur over life.

02

Explanation

The given statement is said to be false because the two-year term bond would have the same interest rate as the average of the one-year bonds. Since the interest rates on one-year bonds are expected to be the same in both years, for example, 5%, then the two-year bond would have an interest rate of 5%. This would make both of the investment choices equally as appealing. Therefore, it is not better to invest in one over the other based on the expectation theory of the term structure.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis. Using bond market graphs, compare the effects on the risk premium between U.S. Treasury debt and comparable-maturity Greek debt.

What is a key function of credit-rating agencies? Do credit-rating agencies always provide reliable information? What was the role of credit-rating agencies in the sub-prime crisis of 2008?

Following a policy meeting on March 19,2009the Federal Reserve made an announcement that it would purchase up to $300billion of longer-term Treasury securities over the following six months. What effect might this policy have on the yield curve?

Predict what will happen to interest rates on a corporation’s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities?

The amount of additional interest investors receive due to various risk premiums changes over time. Sometimes risk premiums are much larger than at other times. For example, the default risk premium was very small in the late 1990s when the economy was so healthy that business failures were rare. This risk premium increases during recessions

Go to http://www.federalreserve.gov/releases/h15 (historical data), and find the following three interest rate listings for AAA- and Baa-rated bonds: the most current listing; the listing for January 5, 2018; and the listings for June 1, 2008, and June 1, 2007. Prepare a http://www.federalreserve.gov/Releases/h15/update/ The Federal Reserve reports the yields on different-maturity U.S. Treasury bonds. graph that shows the interest rate information for these bonds over these three time periods (see Figure 1 for an example). Are the risk premiums stable, or do they change over time?

See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free