Question

15. Suppose the interest rate (return rate) on a 1-year T-bond is 3.0% and that on a 2-year T-bond is 6.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? 16. Stacker's Corporation's bonds have a 10-year maturity, a 10.00% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 2.00%, based on semiannual compounding. What is the bond's price? 17. If the pure expectations theory holds, what does the market expect will be the interest rate (expected return rate) on one-year securities, three years from now? (Iyear maturity yield is 6.0%: 2year maturity yield is 6.1%; 3year maturity yield is 6.3% 4year maturity yield is 6.3 %; 5year maturity yield is 6.396)? (Hints: Draw the timeline and then calculate the interest rate (expected return rate) on two-year securities, two years from now.)

help with 15, 16, 17

Answer 1

15]

As per expectations theory, investing for 2 years at the 2-year rate should result in the same ending value as investing for 1 year at the 1-year rate, and reinvesting the proceeds after 1 year at the 1-year rate 1 year from now.

Let us say the 1-year rate 1 year from now is R. Then :

(1 + 6.0%)2 = (1 + 3.0%) * (1 + R)

R = (1.062 / 1.03) - 1

R = 9.09%