The yield to maturity on one-year zero-coupon bonds is 8.1%. The yield to maturi
ID: 2497104 • Letter: T
Question
The yield to maturity on one-year zero-coupon bonds is 8.1%. The yield to maturity on two-year zero-coupon bonds is 9.1%. What is the forward rate of interest for the second year? (Do not round intermediate calculations. Round your answer to 2 decimal places.) If you believe in the expectations hypothesis, what is your best guess as to the expected value of the short-term interest rate next year? (Do not round intermediate calculations. Round your answer to 2 decimal places.) If you believe in the liquidity preference theory, is your best guess as to next yeara s short-term interest rate higher or lower than in (b)?Explanation / Answer
Calculation of forward interest rate for second year:
Two year rate = 9.1% = 0.091
One year rate = 8.1% = 0.081
Using the formula:
(1+0.091)^2 = (1+0.081) * (1+r2)
(1+r2) = 1.190281 / 1.081
(1+r2) = 1.1011
r2 = 1.1011 – 1 = 0.1011 = 10.11%
Hence forward interest rate for second year = 10.11%
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