Question #22

Reading: Reading 25 The Term Structure and Interest Rate Dynamics

PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf

Page: 9

Status: Correct

Correct Answer: A

Part of Context Group: Q22-23 First in Group
Shared Context
- Wallace now poses a similar question regarding the liquidity preference theory. Which of the following could explain an upward sloping yield curve according to the liquidity preference theory of the term structure of interest rates? A) There is a risk premium associated with more distant maturities. B) The market expects short-term rates to rise through the relevant future. C) There is greater demand for short-term securities than for long-term securities.
Question
Wallace presents the relationships between spot and forward rates according to the pure expectations theory. Which of the following is closest to the one-year implied forward rate one year from now?
Answer Choices:
A. 6.25%
B. 6.58%
C. 5.75%
Explanation
f(1,1) = (1+S2)2 / (1+S1) – 1 = (1.057492)2 / (1.052498) – 1 = 0.0625 or 6.25%
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