Assume that an investor is risk-neutral (i.e. assume that the investor always chooses the investment with the higher expected rate of return even if it is riskier). If the yield on 1-year marketable CD's is 6% while the yield on 2-year marketable CD's is 7% and this investor purchased the 1 year CD, what must (s)he expect to happen to short term interest rates over the coming year?
In question # 1 above, what is the expected interest rate level one year from now that would equalize the expected rate of return on one year and two year CD's if both were held for one year?
If the Fed lowers short term interest rates by 1/2% but investors believe this is just a temporary reduction which will only last a few months, and therefore their expectations of future short term interest rates remain unchanged, what will happen to the yield on 10 year Treasury bonds?
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