Through the expectations hypothesis and the liquidity preference theory of the term structure of interest rates, liquidity must be zero for the forward rate to be equal to the expectations of future short rates.
<h3 /><h3>What is expectation theory?</h3>
Corresponds to a forecast of short-term interest rates by analyzing them against current long-term interest rates.
Therefore, it is a theory used to assist in better understanding and forecasting short-term securities trading in the future.
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Answer:
Price of bond = $916.26
Explanation:
<em>The amount to be paid for the bond would be equal to the Present value (PV) of the redemption Value (RV) plus the present value of the interest payments discounted at the yield rate.</em>
Let us assume that the face value of the bond is 1000 and it is redeemable at par
Interest payment = 6.375%× 1000 = 63.75
PV of interest payment = A× (1- (1+r)^(-n))/r
A- 63.75, r-8.5%, n-5
PV = 63.75 ×(1- (1.085)^(-5))/0.085)
PV = 251.215
PV of RV
PV = RV × (1+r)^(-5)
= 1,000 × (1.085)^(-5)
= 665.045
Price of bond = $916.26
