assume that the interest rate on a one year bond is 7 percent today and the inte
ID: 1236081 • Letter: A
Question
assume that the interest rate on a one year bond is 7 percent today and the interest rates expected on one year bonds in the future are 6 percents in 1-year, 5 percent in 2-year , and 4 percent in three years bond.a. according to the exceptions theory of the term structure, what are interest rate today on a 2-year bond, a 3- year bond and a 4- year bond?
b. if the term premium is equal to 0.5% times the number of years to maturity of a bond for times to maturity of two, three, and four years, what are the interest rates today on a 2-year bond, and 3-year bond, and a 4- year bond?
Explanation / Answer
assume that the interest rate on a one year bond is 7 percent today and the interest rates expected on one year bonds in the future are 6 percents in 1-year, 5 percent in 2-year , and 4 percent in three years bond.
a. according to the exceptions theory of the term structure, what are interest rate today on a 2-year bond, a 3- year bond and a 4- year bond?
interest on a two year bond = 0.5(5) = 0.025 = 2.5%
interest on a three year bond = 0.5(4) = 0.02 = 2%
interest on a four year bond = 0.5(3) = 0.015 = 1.5%
b. if the term premium is equal to 0.5% times the number of years to maturity of a bond for times to maturity of two, three, and four years, what are the interest rates today on a 2-year bond, and 3-year bond, and a 4- year bond?
2: 0.025 • (1.005) = 0.025125
==> 2.5% interest
3: 0.002 • (1.005) = 0.0201
==> 2.01% interest
4: 0.0015 • (1.005) = 0.015075
==> 1.51% interest
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