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1 CHAPTER 6 THE STRUCTURE OF INTEREST RATES ANSWERS TO END-OF-CHAPTER QUESTIONS 1. Using the Federal Reserve Bulletin, the Federal Reserve Bank of St. Louis web site (FRED), or The Wall Street Journal, plot the yield curve for U.S. Treasury securities on a quarterly basis for this year . Given your knowledge of the term structure of interest rates, what would be your economic forecast for next year? See the U.S. Treasury Bulletin , quarterly, for plots of the yield curve or The Wall Street Journal , daily in the "Credit Markets" section or on the "Markets Lineup," the second page in the Money & Investing section. The Federal Reserve Bulletin provides accessible, limited data for a plot. The "U.S. Treasury Securities" section of The Wall Street Journal provides extensive, current maturity/yield data for plotting a yield curve in the section titled “Treasury Bonds, Notes & Bills”. 2. Summarize the expectation theory and the segmentation theory of the term structure of interest rates . Are these theories in any way related or are they alternative explanations of the term structure ? The expectation theory states that the shape of the yield curve is related to investors' expectations of future interest rate levels. The segmentation theory states that supply and demand factors within various segments (maturities) of the yield curve determine the overall shape of the yield curve. The expectations theory is related to the liquidity premium theory, but is not related to the market segmentation theory. 3. A commercial bank made a three-year term loan at 10 percent . The bank's economics department forecasts that one and two years in the future, the one-year interest rate will be 10 percent and 14 percent, respectively . The current one-year rate is 8 percent . Given that the bank's forecast is reliable, has the bank set the three-year rate correctly ? Given the bank's forecast, the three-year rate ( t R 3 ) should be equal to 10.64 percent using Equation (6.1), [(1.08)(1.10)(1.14)] 1/3 -1 = 10.64%. Thus, the bank's loan rate is too low, and it will be deluged with applications. The bank will have to raise rates to reflect the market's expectations. 4.
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This note was uploaded on 11/08/2011 for the course MAT/FIN 272 taught by Professor Burns during the Spring '11 term at Central Connecticut State University.

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