15-Term StructureII

# 15-Term StructureII - Class Business Current Events...

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Class Business Current Events Upcoming Homework Expectations Hypothesis More generally for n -period bond: i t + i e t+1 + i e t+2 + . .. + i e t+(n–1) i nt = n In words : Interest rate on long bond = average short rates expected to occur over life of long bond Numerical example: One-year interest rate over the next five years 5%, 6%, 7%, 8% and 9%: Interest rate on two-year bond: (5% + 6%)/2 = 5.5% Interest rate for five-year bond: (5% + 6% + 7% + 8% + 9%)/5 = 7% Interest rate for one to five year bonds: 5%, 5.5%, 6%, 6.5% and 7%.

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The Expectations Hypothesis Does this hypothesis explain the three observations we started with? 1. Interest rates of different maturities will move together. We can see this holds from the previous equation. 2. Yields on short-term bonds will be more volatile than yields on long-term bonds. Long-term rates are averages of short-term rates, so changing one short- term rate has little effect on the long term rate. 3. This hypothesis cannot explain why long-term yields are normally higher than short term yields. It implies that the yield curve slopes upward only when interest rates are expected to rise. This hypothesis would suggest that interest rates are normally expected
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## This note was uploaded on 11/22/2011 for the course ECONOMIC ManEc352 taught by Professor Keithvorkink during the Winter '11 term at BYU.

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15-Term StructureII - Class Business Current Events...

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