$1,000 par value zero coupon bonds, ignore liquidity premiums
-The expected two year interest rate three years from now should be _________.

Question

$1,000 par value zero coupon bonds, ignore liquidity premiums 
-The expected two year interest rate three years from now should be _________.

Quizplus · Accepted Answer

To solve the problem, we need to use the formula for calculating the implied forward rate:

(1 + r2)^2 = (1 + r1) x (1 + F23)

where:
r1 = current one-year interest rate
r2 = current two-year interest rate
F23 = expected two-year interest rate three years from now

We can solve for F23 by plugging in the given values:

(1 + 0%)^2 = (1 + 5%) x (1 + F23)
1 = 1.05 x (1 + F23)
F23 = 1/1.05 - 1
F23 = 4.76%

Therefore, the expected two-year interest rate three years from now should be 14.89% (5% + 4.76%). The correct answer is C.

$1,000 Par Value Zero Coupon Bonds, Ignore Liquidity Premiums