Determinants of Interest Rates for Individual Securities The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 3.25 percent and on 20-year Treasury bonds is 5.50 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 10-year Treasury bond purchased ten years from today, E(10r10).
|As per Interest expectation theory, on the basis of long term interest rates, short term interest rates in futures can be predicted.|
|Current rate on 10-Year Treasury bonds||3.25%||0.0325|
|Current rate on 20-Year Treasury bonds||5.50%||0.055|
|Maturity risk premium is zero.|
|So, as per expectation theory, Expected rate (forward rate) on a 10-Year bonds purchased ten years from today can be calculated by below :|
|(1 + Forward interest rate)^n = (1 + Longer time Spot rate)^n / (1+ Shorter time Spot rate)^n|
|(1+F)^10 = (1 + 0.055)^20 / (1+0.0325)^10|
|F =||0.07799 or||7.80%|
|So, Expected rate on a 10-Year Treasury bond purchased ten years from today is 7.80%.|
Get Answers For Free
Most questions answered within 1 hours.