Question

Suppose the term structure of interest rates has these spot interest rates: r1 = 6.5%. r2 = 6.3%, r3 = 6.1%, and r4 = 5.9%.

a. What will be the 1-year spot interest rate in three years if the expectations theory of term structure is correct? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

1-year spot in 3 years %

b. If investing in long-term bonds carries additional risks, then how would the risk equivalent of a 1-year spot rate in three years relate to your answer to part (a)?

Less than

Greater than

Equal to

Answer 1

The solution to the question is provided below for your refetrnce

1.

=(1+rate for 4 years)^4/(1+rate for 3 years)^3-1

=1.059^4/1.061^3-1

=5.3022%

2.

Greater than