Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{ll}
\text { Year } &\text { Forward Interest Rate }\
0 & 4\% \text { (today) } \
1 & 5\% \
2 & 6\%\
3&7\%
\end{array}$ What is the yield to maturity of a 3-year zero-coupon bond?
A) 9.00%
B) 7.00%
C) 5.00%
D) 4.00%
E) None of the options are correct.

Question

Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{ll}
\text { Year } &\text { Forward Interest Rate }\ 
0 & 4\% \text { (today) } \
1 & 5\% \
2 & 6\%\
3&7\%
\end{array}$  What is the yield to maturity of a 3-year zero-coupon bond?
A) 9.00%
B) 7.00%
C) 5.00%
D) 4.00%
E) None of the options are correct.

Quizplus · Accepted Answer

The yield to maturity (YTM) of a 3-year zero-coupon bond is the geometric average of the forward rates over the 3 years: $(1.04 \times 1.05 \times 1.06)^{1/3} - 1 \approx 5\%$.

Suppose That All Investors Expect That Interest Rates for the 4