Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{lc}
\text { Year } & \text { Forward Interest Rate } \
0 & \text { (today) } 3\% \
1 & 4\% \
2 & 5\% \
3 & 6\%
\end{array}$
What is the yield to maturity of a 3-year zero-coupon bond?
A) 7.00%
B) 9.00%
C) 6.99%
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: $\begin{array}{lc}
\text { Year } & \text { Forward  Interest Rate } \
0 & \text { (today) } 3\% \
1 & 4\% \
2 & 5\% \
3 & 6\%
\end{array}$
 What is the yield to maturity of a 3-year zero-coupon bond?
A) 7.00%
B) 9.00%
C) 6.99%
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: $(1.03 \times 1.04 \times 1.05)^{1/3} - 1$, which approximates to 4.00%.

Suppose That All Investors Expect That Interest Rates for the 4