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alekssr [168]
3 years ago
11

You want to decide whether to invest in zero-coupon bonds or not. Currently, the yield to maturity of these zero-coupon bonds fo

r the one-year is 8% and for the two-year is 9%. Given this information what is the forward rate of interest for the second year?
a. 10.01%
b. 8%
c. 9.2%
d. 3.25%
Business
1 answer:
kirza4 [7]3 years ago
5 0

Answer:

The forward rate of interest for the second year is;

a. 10.01%

Explanation:

<em>Step 1: Determine the 1 year final value of the investment</em>

The formula for calculating the final value for the 1 year investment is;

F.V=P.V(1+r)

where;

F.V=final value

P.V=present value

r=yield to maturity

In our case;

F.V=unknown

P.V=x

r=8%=8/100=0.08

replacing;

F.V=x(1+0.08)=1.08 x

<em>Step 2: Determine the 2 year final value of the investment</em>

Using the formula;

F.V=P.V(1+r)²

where;

F.V=unknown

P.V=x

r=9%=9/100=0.09

replacing;

F.V=x(1+0.09)²=1.1881 x

<em>Step 3: Determine the forward rate of interest for the second year</em>

The forward rate of interest can be expressed as;

forward rate of interest=(2-year future value/1-year future value)-1

replacing;

forward rate of interest=(1.1881 x/1.08 x)-1=0.10009×100=10.01%

forward rate of interest=10.01%

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