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The current market interest rate for one year maturity bond is 10%. The forward rate for a one year investment starting in on

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Answer #1

From the expectations theory of term structure we know,

Where r2 is the two year maturity interest rate

is the forward rate for 1 year investment starting in one year from now=8%=.08

is the one year maturity rate.=10%=.1

Therefore

(1+r2)^2=1.188

1+r2=1.089

Therefore,r2=.0899=8.99%

Therefore r2 is between 8% and 10%.

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