Question

Assume the current term structure of interest rates follows this table. Maturity in Years Rate 11 5% 2 6% 3 9% 4 10% What does the market expect the 1-year rate will be two years from now? A. None of the other options are correct B. 3.25% C. 15.26% D. 7.81% E. 9.00%

Answer 1

Hello

YOUR REQUIRED ANSWER IS OPTION C : 15.26%

We know that:

$f(T^*,T)=[\frac{(1+r_{T^*+T})^{T^*+T}}{(1+r_{T^*})^{T^*}}]^{\frac{1}{T}}-1$

Hence,

$f(2,1)=[\frac{(1+r_{3})^{3}}{(1+r_{2})^{2}}]^{\frac{1}{1}}-1$

$f(2,1)=[\frac{(1.09)^{3}}{(1.06)^{2}}]-1=0.1526 =15.26\%$

Thanks!

Please drop an upvote if you find this helpful.