The yield to maturity on one-year zero coupon bonds is 4.98%. The yield to maturity on two-year zero coupon bonds is 6.94%.
a. What is the forward rate of interest for the
second year? (Round your answer to 2 decimal
places.)
Forward rate
%
b. According to the expectations hypothesis, what is the expected value of the one-year interest rate for next year? (Round your answer to 2 decimal places.)
Expected value
a. What is the forward rate of interest for the second year?
(1+YTM1) * (1+f2) = (1+YTM2)2
= (1.0498) * (1+f2) = (1.0694)2
= (1+f2) = (1.0694)2 /1.0498
f2 = 1.089366-1 = 0.089366 or 8.9366%
The forward rate of interest for the second year = 8.94%
b. According to the expectations hypothesis, what is the expected value of the one-year interest rate for next year?
According to the expectations theory, the forward rate might be equal to the expected value of the one year interest rate for next year. Hence it would be 8.9366% or 8.94% (rounded of)
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