Question

If the 1-year treasury bill coupon-equivalent yield is presently 5.25 % and the 2 - year...

If the 1-year treasury bill coupon-equivalent yield is presently 5.25 % and the 2 - year treasury note is yielding 5.95,

a. what is the implied 1-year forward rate?

b. Should a corporate investor buy two consecutive 1 year securities or buy and hold the 2 year security if his or her forecast for the 1 year forward rate is 7% (assuming that he or she trusts the reliability of the forecast)

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Homework Answers

Answer #1

Solution:

1- Year yield =5.25%

2-Year yield = 5.95%

Part A )

Part B )

A corporate investor should buy two consecutive 1-year securities as the 1-year implied forward rate is 6.65% while her calculated rate is 7%. This forecasted rate is more than the implied forward rate hence the return will be higher than the 2-year security.

Comparison:

Suppose we have $100 to invest then the future value in 2-year security

FV = 100 * (1+5.95%)^2 = 112.25

future value when investing in 2 consecutive security

FV = 100 * (1+5.25%) * (1+7%) = 112.62

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