Question

The current yield curve for Treasury zero-coupon bonds is as follows:

Maturity YTM

1)7%

2 )6%

3) 8%

If the market expectations are accurate, what will the two-year zero coupon yield be one year from now? Answer in percentages, with two decimal places.

Answer 1

(1 + 3 year YTM)³ = (1 + 1 year YTM) * (1 + Expected 2 year zero coupon yield 1 year from now)²

(1 + 8%)³ = (1 + 7%) * (1 + Expected 2 year zero coupon yield 1 year from now)²

(1 + Expected 2 year zero coupon yield 1 year from now)² = (1 + 8%)³ / (1 + 7%)

(1 + Expected 2 year zero coupon yield 1 year from now)² = 1.1773

(1 + Expected 2 year zero coupon yield 1 year from now) = (1.1773)^{(1 / 2)}

(1 + Expected 2 year zero coupon yield 1 year from now) = 1.0850

Expected 2 year zero coupon yield 1 year from now = 8.50%