Problem:
Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 5.40%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond.
Required:
Question 1: What is the yield on a 1-year T-bond expected to be one year from now? Explain in detail and show all work.
A. 4.95%
B. 5.75%
C. 5.05%
D. 5.00%
E. 5.80%