A one year Treasury bill has a yield of 5%. A bond will pay $40 at the end of year one and $1,040 at the end of year 2. If its market value is $946.50, the two-year spot rate is

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The two-year spot rate can be found by solving for the interest rate in the present value formula, given the bond's cash flows and its current market price. The formula is: $PV = \frac{C_1}{(1+r)^1} + \frac{C_2}{(1+r)^2}$, where $PV$ is the present value (market price of the bond), $C_1$ and $C_2$ are the cash flows in year 1 and year 2, respectively, and $r$ is the interest rate (spot rate) we are solving for.Given:- $PV = \$946.50$- $C_1 = \$40$- $C_2 = \$1,040$Plugging these values into the formula gives us:$$946.50 = \frac{40}{(1+r)} + \frac{1040}{(1+r)^2}$$Solving this equation for $r$ gives us the two-year spot rate. Through calculation, we find that $r \approx 7\%$, which corresponds to choice C.

A One Year Treasury Bill Has a Yield of 5