Calculate the implied future ONE YEAR Intrest rates for the following yield curv

Question

Calculate the implied future ONE YEAR Intrest rates for the following yield curve (from 1 to 2, 2 to 3) Assume annual compounding Year Rate ,% 7.80 7.50 7.30 You are given the following prices of US Treasuary strips (discount or zero coupon bonds, assume annual compounding): Compute the spot rates for years 1, 2 and 3. Now, suppose you are offered a project which returns the following cash flows: $300m at the end of year 1 $210m at the end of year 2 $400m at the end of year 3 The project costs $ 600m today. Calculate the NPV of the project using the spot rates computed above.

Explanation / Answer

#1. Implied future One year interest rate

Implied future one year interest rate for yield curve 1 to 2,

Let the implied future one year for yield curve 1 to 2 be i,

(1+0.078)(1+i) = (1+0.075)2

i = (1.156/1.078) - 1

= 1.072 - 1 = 0.072 i.e. 7.20%

Implied future one year interest rate for yield curve 2 to 3.

Let the implied future one year for yield curve 2 to 3 be r,

(1+0.075)(1+r) = (1+0.073)2

r = (1.151/1.075) - 1

= 1.071 - 1 = 0.071 i.e. 7.10%

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