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solution

Module 2:
Suppose in the Wall Street Journal you see the following
current (spot) interest rates for Treasury bonds on July 16,, 2021
with an upward sloping yield curve:


10-year bond rate =1.31%; 20-year bond rate =
1.86%

a. Under the expectations theory, what is the
expected 10-year bond rate (forward rate) 10 years from now?
Based on your answer, what are rates expected to do (rise/fall/stay
the same)? Explain why

Expected 10-year bond rate 10 years from now =
_________________

(Be sure to show your work here).

Rate are expected to ___________ because
________________________

b. For the same above if there is a
liquidity premium of 0.25% for a 10-year bond and 0.50% for a
20-year bond, under the liquidity premium theory (adjusting for
liquidity premiums incorporated in bond rates) what is the new
expected 10-year bond rate 10 years from now? Based on your
answer, what are rates expected to do (rise/fall/stay the same)?
Explain why.

Expected Rate with LP __________ Rates Expected to
__________________

(Be sure to show your work here).

c. Explain how interest rates are determined under
the market segmentation theory for respectively short-term and
long-term interest rates. What is the flaw in this
theory?

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