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4 July, 07:59

A one-year bond has an interest rate of 5% today. Investors expect that in one year, a one-year bond will have an interest rate equal to 7%. Investors expect that in two years, a one-year bond will have an interest rate equal to 9%. According to the expectations theory of the term structure of interest rates, in equilibrium, a three-year bond today will have an interest rate equal to

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Answers (2)
  1. 4 July, 08:08
    0
    6%

    Explanation:

    Current interest rate on one year bond = 5%

    Forward interest rate on one year bond = 7%

    To Calculate the interest rate on two year bond we use this:

    Interest rate = [Current interest rate on one year bond + Forward interest rate on one year bond]/2

    Interest rate = [5 + 7]/2 = 12/2 = 6%

    Therefore,

    The interest rate on two-year bond is equal to 6%.
  2. 4 July, 08:21
    0
    A one-year bond has an interest rate of 5% today. Investors expect that in one year, a one-year bond will have an interest rate equal to 7%. Investors expect that in two years, a one-year bond will have an interest rate equal to 9%. According to the expectations theory of the term structure of interest rates, in equilibrium, a three-year bond today will have an interest rate equal to 7%.

    Explanation:

    The current interest rate on one year bond = 5%

    The forward interest rate on one year bond = 7%

    The forward interest rate on one year bond = 9%

    We can now calculate the interest rate on a three-year bond as below:

    Interest rate = [Current interest rate on one year bond + Forward interest rate (7%) on one year bond + Forward interest rate (9%) ]/3

    Interest rate = [5 + 7+9]/3 = 21/3 = 7%

    Therefore,

    The interest rate on a three-year bond is equal to 7%.
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