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The table below is the YTM of U
The table below is the YTM of U.S. Treasuries with different maturities on April 1, 2020
|
1 yr. |
2 yr. |
3 yr. |
5 yr. |
7 yr. |
|
0.16% |
0.23% |
0.28% |
0.37% |
0.51% |
a. What is the expected two-year rate in three years according to the Pure Expectations Theory?
b.What is an inverted yield curve? Give one reason that may cause the yield curve to invert.
Expert Solution
Solution
1.
Expected two year rate in three years is given by the formula as
=((1+r5)^5/(1+r3)^3)^(1/2)-1
=((1+0.37%)^5/(1+0.28%)^3)^(1/2)-1
=0.51%
2.
Inverted yield curve is when long term maturity bonds have lower yield than short term maturity bonds, i.e., long-term yields fall below short-term yields
Most investors believe short-term rates are going to decline sharply at some point in future. One reason that the yield may be inverted because investors expect recession
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