Reading 65: Understanding Yield Spreads - LOS c, (Part 1) correct, expected, following, hypothesis, class

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6.Which of the following is a correct interpretation of forward rates under the pure expectations hypothesis? Forward rates are equal to the expected future:

A)   risk premiums on short-term bills.

B)   risk premiums on long-term bonds.

C)   spot rates.

D)   rate differences between short and long-term bonds.

7.According to the pure expectations theory an upward-sloping yield curve implies:

A)   interest rates are expected to decline in the future.

B)   interest rates are expected to increase in the future.

C)   longer-term bonds are riskier than short-term bonds.

D)   shorter-term bonds are less risky than longer-term bonds.

8.Suppose that the one-year forward rate starting one year from now is 6%. Which of the following statements is TRUE under the pure expectations hypothesis? The expected:

A)   future risk premium for short-term bills is 6%.

B)   future one-year spot rate in one year's time is equal to 6%.

C)   future risk premium for long-term bonds is 6%.

D)   one-year forward rate in one year's time is equal to 6%.

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答案和详解如下：

6.Which of the following is a correct interpretation of forward rates under the pure expectations hypothesis? Forward rates are equal to the expected future:

A)   risk premiums on short-term bills.

B)   risk premiums on long-term bonds.

C)   spot rates.

D)   rate differences between short and long-term bonds.

The correct answer was C)

The pure expectations theory purports that forward rates are solely a function of expected future spot rates.

7.According to the pure expectations theory an upward-sloping yield curve implies:

A)   interest rates are expected to decline in the future.

B)   interest rates are expected to increase in the future.

C)   longer-term bonds are riskier than short-term bonds.

D)   shorter-term bonds are less risky than longer-term bonds.

The correct answer was B)

According to the expectations hypothesis, the shape of the yield curve results from the interest rate expectations of market participants.  More specifically, it holds that any long-term interest rate simply represents the geometric mean of current and future 1-year interest rates expected to prevail over the maturity of the issue.  The expectations theory can explain any shape of yield curve. 

Expectations for rising short-term rates in the future cause a rising (upward-sloping) yield curve; expectations for falling short-term rates in the future will cause long-term rates to lie below current short-term rates, and the yield curve will decline (or slope downward).

Thus, an upward-sloping yield curve implies that interest rates are expected to increase in the future.

8.Suppose that the one-year forward rate starting one year from now is 6%. Which of the following statements is TRUE under the pure expectations hypothesis? The expected:

A)   future risk premium for short-term bills is 6%.

B)   future one-year spot rate in one year's time is equal to 6%.

C)   future risk premium for long-term bonds is 6%.

D)   one-year forward rate in one year's time is equal to 6%.

The correct answer was B)

Under the pure expectations hypothesis forward rates are equal to expected future spot rates.