Question

Question 5 (0.9 points) Situation 6-2 The current 1-year, 2-year, and 3-year bond interest rates are 4%, 5%, and 6%, respectively. The 1-year, 2-year, and 3-year term premia are estimated to be 0, 1, and 2 percent, respectively. Using the information in Situation 6-2, the expectations theory of the term structure predicts that the expected 1-year bond interest rate is % two years from now. Question 6 (0.9 points) Over the next three years, the expected path of 1-year interest rates is 1, 2, and 1 percent, and the 1-year, 2-year, and 3-year term premia are 0, 0.2, and 0.5 percent, respectively. Using the information, the liquidity premium theory of the term structure predicts that the current interest rate on 3-year bond is % (round to one decimal place x.x).

Answer 1

Q - 5

Expected 1 year bond interest rate 2 years later = (1 + S3)³ / (1 + S2)² - 1= (1 + 6%)³ / (1 + 5%)² - 1 = 8.03%

Q - 6

The current interest rate on 3 year bond = (1% + 2% + 1%) / 3 + 0.5% = 1.83%