Concept explainers
To determine: The market’s expectation of the yield curve as per the expectations hypothesis from now to 1 year and further calculate the expected values of next year yields on bonds after one year, two years and three years.
Introduction:
Yield-curve analysis: It is a technique to calculate the difference in interest rate between the note value and the term of to maturity.
Answer to Problem 9PS
The forward rate after one year is 7%; after two years it is 7.5% and after three years it is 8.51%.
Explanation of Solution
We have been given the following information:
Bond | Years to Maturity | YTM (%) |
A | 1 | 5 |
B | 2 | 6 |
C | 3 | 6.5 |
D | 4 | 7 |
We have to calculate the expected rate. Expected rate is called as expected hypothesis. The following formula can be used for calculation.
Calculation of expected rate after one year:
When converted into percentages, it becomes 7%.
Calculation of expected rate after two years
When converted into percentages, it becomes 7.5%.
Calculation of expected rate after 3 years:
The percentages have to be converted into decimals by dividing it by 100.
When converted into percentages, it becomes 8.51%.
Therefore, the forward rate after one year is 7%; after two years it is 7.5% and after three years it is 8.51%.
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Chapter 15 Solutions
INVESTMENTS-LOOSELEAF
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