Question

If you note the following yield curve in The Wall Street Journal, what is the one-year forward rate for the period beginning one year from today, 2f1 according to the unbiased expectations theory? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) Maturity Yield One day 1.10 % One year 1.62 Two years 1.86 Three years 1.97

Answer 1

Based on unbaised expectations theory, short term rates are indicator of long term rates.

In other words, if you invest in a two year bond or if you invest in a one year bond and then the procceds from maturity are invested in another 1 year bond (such that investment horizon remains 2 years), the yields in both cases would be same.

(1 + 2Yr rate)² = (1 + 1 Yr Rate) * (1 + 1 Yr Rate 1 Yr from now)

(1 + 1.86%)² = (1 + 1.62%) * (1 + 1 Yr Rate 1 Yr from now)

1.0210 = (1 + 1 Yr Rate 1 Yr from now)

1 Yr Rate 1 Yr from now = 0.03091 = 2.10%