Question

The yields of four zero-coupon bonds of varying maturities are as follows:

Maturity YTM

1 6.1%

2 6.2%

3 6.3%

4 6.4%

If you expect the implied term structure to be the same next year as it is this year, what is the expected return on the 3-year zero coupon bond over the coming year? Please express your answer in percent, rounded to the nearest basis point.

Answer 1

what is the expected return on the 3-year zero coupon bond over the coming year?

(1 + one year interest rate) * (1 + 3 year interest rate one year from now)^3 = (1 + 4 year interest rate)^4

(1 + 0.061) * (1 + 3 year interest rate one year from now)^3 = (1 + 0.064)^4

1.061 * (1 + 3 year interest rate one year from now)^3 = 1.2816

(1 + 3 year interest rate one year from now)^3 = 1.2080

(1 + 3 year interest rate one year from now) = 1.065

3 year interest rate one year from now = 6.50%