Question

Consider the following $1,000 par value zero-coupon bonds: Bond Years to Maturity 10 points MUA WNP YTM(%) 5% 6 6.5 eBook According to the expectations hypothesis, what is the market's expectation of the yield curve one year from now? Specifically, what are the expected values of next year's yields on bonds with maturities of (a) one year? (b) two years? (c) three years? (Do not round intermediate calculations. Round your answers to 2 decimal places.) Print Years to Maturity YTM (%) Bond B с References | 3

Answer 1

Theoretical Interest Rate after n years for t years Bond = [{(t+1)*(Interest Rate for t+1)}-{n*Interest Rate for n}]/[{t+1}-n]

Accordingly,

Theoretical Interest Rate after 1 year for 1 year Bond = [{2*6}-{1*5}]/[2-1] = [12-5]/1 = 7%

Theoretical Interest Rate after 1 year for 2 years Bond = [{3*6.5}-{1*5}]/[3-1] = [19.5-5]/2 = 7.25%

Theoretical Interest Rate after 1 year for 3 years Bond = [{4*7}-{1*5}]/[4-1] = [28-5]/3 = 7.67%