Discuss what the pure expectations theory would imply about the yield curve.
Discuss what the pure expectations theory would imply about the yield curve.
1. (Expected Rate of Return and Risk) B. J. Orange Enterprises is evaluating a security. One-year Treasury bills are currently paying 1.9 percent (with little risk – 1 percent). Calculate the investment’s expected return and its standard deviation. Should Orange invest in this security or the Treasury bills? You should calculate the expected return, standard deviation, and coefficient of variation.
Probability Return
.15 6%
.30 5%
.40 11%
.15 14%
2. (Historic Rate of Return and Risk) Consider an investment in one of two common stocks. Given the information that follows, which investment was better, based on risk (as measured by the standard deviation), return, and coefficient of variation?
Common Stock A Common Stock B
Return Return
10% 8%
13% 15%
20% 19%
Question 2.
Go to a financial Web site, such as
finance.yahoo.com, http://www.google.com/finance, or moneycentral.msn.com
. Obtain information on the yields and maturity for:
1. U.S. treasuries
2. Municipal bonds
3. Corporate bonds
Discuss what the pure expectations theory would imply about the yield curve. Compare and contrast the yields and maturities for each of the securities. Discuss which you would hold and why relative to interest rate risk. You must submit your backup in Excel or other supporting documentation showing how answers were reached.
