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Consider the bond market to be in equilibrium according to our complete theory of the term

Consider the bond market to be in equilibrium according to our complete theory of the term

Consider the bond market to be in equilibrium according to our complete theory of the term structure of interest rates. The current interest rate on one-year bonds is 5 percent, and you believe, as does everyone in the market, that in one year the interest rate on one-year bonds will be 6 percent and in two years the interest rate on one-year bonds will be 6.5 percent. Assume that there is no term premium on a one-year bond. Suppose the term premium equals 0.5 percent A?´ the number of years to maturity, for two-year bonds and three-year bonds. The interest rate today on the two-year bond is ____ and the interest rate today on a three-year bond is ____.

Select one:

a. 5.5 percent; 5.8 percent

b. 6.0 percent; 6.3 percent

c. 6.2 percent; 6.8 percent

d. 6.5 percent; 7.3 percent

Abhinav 03-Dec-2019

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