1. Assess the following claims as either “True”, “False” or “Uncertain” and brie?y explain your response:
(a) “Assuming that the expectations theory of the term structure is true, if the market believes that interest rates are likely to decrease in the near future borrowers would immediately increase their supply of shortterm securities.”
(b) “Assume you have a collection of municipal bonds and corporate bonds of similar maturities and default risk (i.e. both sets of bonds carry a rating of “AA+” from Standard and Poor’s). Accordingly, a yield curve formed from municipal bonds will be higher than a yield curve formed from the corporate bonds because of their tax-advantaged status.”
2. explain: (i.) The primary difference between the expectations theory of the term structure and the liquidity theory of the term structure, and (ii.) Why forward rates are biased predictors of future short rates if the liquidity theory holds.