Question

A one-year bond currently pays 3.5% interest. It's expected that it will pay 4.5% next year and 4% the following year. The two-year term premium is 0.5% while the three-year term premium is 0.35%. What is the interest rate on a three-year bond

Answer 1

Answer:

The interest rate on a three year bond is 4.35%

Explanation:

The interest rates are given as 3.5%, 4.5% and 4%. and the three year term premium is given as 0.35%

So the interest rate is given as

$i=\frac{i_1+i_2+i_3}{3}+p\\i=\frac{3.5\%+4.5\%+4\%}{3}+0.35\%\\i=4\%+0.35\%\\i=4.35\%$

So the interest rate on a three year bond is 4.35%