Question

The yield to maturity on one-year zero coupon bonds is 4.54%. The yield to maturity on two-year zero coupon bonds is 6.62%.

a. What is the forward rate of interest for the second year?

Forward rate =

According to the expectations hypothesis, what is the expected value of the one-year interest rate for next year?

Expected Value=

Answer 1

One Year Int Rate after 1 Year = [ (1+ 2 Year Zero Coupon Bond YTM)^2 / ( 1 + One Year Zero Coupon Bond YTM ) ] - 1

= [ ( 1 + 0.0662)^2 / ( 1 + 0.0454 ) ] - 1

= [ 1.0662^2 / 1.0454 ] - 1

= [ 1.1368 / 1.0454 ] - 1

= 1.0874 - 1

= 0.0874 i.e 8.74%