Question

Suppose the term structure of risk-free interest rates is as shown below:

Term	1 yr	2 yr	3 yr	5 yr	7 yr	10 yr	20 yr
Rate (EAR %)	2.09	2.41	2.69	3.38	3.73	4.28	4.97

a. Calculate the present value of an investment that pays $1,000 in two years and $4,000 in five years for certain.

b. Calculate the present value of receiving $600 per year, with certainty, at the end of the next five years.  To find the rates for the missing years in the table, linearly interpolate between the years for which you do know the rates.  (For example, the rate in year 4 would be the average rate in year 3 and year 5.)

c. Calculate the present value of receiving $1,900 per year, with certainty, for the next 20 years.  Infer rates for the missing years using linear interpolation.  (Hint: Use a spreadsheet.)

Answer 1

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