1. Suppose the following interest rate structure was observed in 2000 and 2001:
Bond 2000 2001
3-month treasury bill 12.00 14.00
1-year government bond 12.50 14.50
3-year government bond 12.75 14.75
5-year government bond 13.00 15.00
10-year government bond 13.30 15.30
a) In light of the expectations hypothesis, explain what the yield curves say about future interest rates.
b) If real interest rates were the same in both years, what might have caused the shift in the yield curve?
2. Consider the following forecasts of future interest rates:
Yield R1 E11 E12 E13 E14
% 6.6 6.4 5.6 5.2 5
Using the expectations hypothesis, predict the shape of the yield curve.
3. What would be the possible explanation for a flat yield curve given by the following theories?
a) expectations hypothesis
b) market segmentation hypothesis
c) liquidity premium theory
4. If you thought an economic expansion was imminent, would you be better off holding short-term or long-term bonds? Explain.