Question

# Determinants of Interest Rates for Individual Securities The Wall Street Journal reports that the current rate...

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 (1+f)^10 = 2.917757 / 1.376894 (1+F)^10 = 2.119086 1+F = 1.07799 F = 0.07799 or 7.80% So, Expected rate on a 10-Year Treasury bond purchased ten years from today is 7.80%.

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