Question

1. Assume that as of today we have an annualized two-year interest rate of 11 percent, while the current one-year interest rate is 9 percent. Given this information, estimate the one-year forward rate and describe how you got the answer. 2. Over the last six months, the long-term yields declined, while short-term yields remained the same. Analysts stated that the shift was due to revised expectations of interest rates. Given the shift in the yield curve, what do you expect has happened to the demand for long-term borrowing?

Answer 1

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Answer (1):

To calculate the One-year forward rate, use the below formula: nuta = (1+, (1+i) Where, 1 = forward rate or anticipated one year interest rate one year from now;

where i₂ = 11% and i₁ = 9%

=> _i+1r_t = (1+0.11)²/(1+0.09) - 1 = 13.04%

Answer (2):

Since the long-term yield has declined it implies that the firms have decreased the demand for long term funds. A lower demand has reduced the cost of funds which is the yield for the funds. During times of recession the yield curve gets inverted. This implies that the short term yield is higher than the longer term yields and people do not expect their investment to grow in the long term. Looking at the current structure of the yield curve it looks like the economy is on the verge of a recession. The short term yield remains the same while the long-term yields are declining.