Question

Consider the following $1,000 par value zero-coupon bonds:

Answer 1

Answer:

The expected 1-year interest rate 2 years from now should be 8.11%

Explanation:

The Zero-coupon rate bond is a bond that does not offer the coupon payment. This coupon is issued at a deep discount value. The only cash flow associated with this bond is the face value at the maturity date.

Use following equation to calculate the The expected 1-year interest rate 2 years from now

( 1 + 1 years maturity rate)^1 x ( 1 + 2 years maturity rate)^2 = ( 1 + 3 years maturity rate)^3

( 1 + 1 years maturity rate) x ( 1 + 6.60%)^2 = ( 1 + 7.10%)^3

( 1 + 1 years maturity rate) x ( 1.0660)^2 = ( 1.0710)^3

( 1 + 1 years maturity rate) = ( 1.0710)^3 / ( 1.0660)^2

( 1 + 1 years maturity rate) = 1.228481 / 1.136356

1 + 1 years maturity rate = 1.081071

1 years maturity rate = 1.081071 - 1

1 years maturity rate = 0.081071

1 years maturity rate = 8.1071%

1 years maturity rate = 8.11%