Question

According to the Local expectations theory, what would be the difference in the one-month total return if an investor purchased a five-year zero-coupon bond versus a two-year zero-coupon bond?

Answer 1

Answer: In finance and economics, the local Expectation theory is the theory that Suggests that determs of bond with different maturities should be the same over the short-term Investment horizon. of an investor purchases two bonds where one bond comes with 5 years to maturity and another comes with 2 years to maturity, the local expectation theory Implies that over the short term investment period se 1 month both bonds will deliver equivalent returns to the Investor The rationale behind the theory is that a the returns of bonds are primarily based on market expectations about forward rates _94 alsó suggests that bands with longer maturities do not compensate investors for Interest rate rick or reinvestment rate risk 00 .