Given the yield on a 3 year zero-coupon bond is 7.2% and forward rates of 6.1% in year 1 and 6.9% in year 2,what must be the forward rate in year 3?

Question

Quizplus · Accepted Answer

To answer this question, we can use the formula for calculating forward rates:

(1 + y)^n = (1 + f1)^1 x (1 + f2)^2 x (1 + f3)^3

where:
y = Yield to maturity
f1, f2, f3 = Forward rates for year 1, year 2, and year 3.

Substituting the given values, we get:

(1 + 0.072)^3 = (1 + 0.061)^1 x (1 + 0.069)^2 x (1 + f3)^3

Solving for f3, we get:

f3 = (1 + 0.072)^3 / [(1 + 0.061)^1 x (1 + 0.069)^2]^(1/3) - 1

f3 = 0.086 or 8.6%

Therefore, the answer is B) 8.6%.

Given the Yield on a 3 Year Zero-Coupon Bond Is