Question

You observe that the return on a 2-year Treasury bond is 4% and the return on a 3-year Treasury Bond is 7.2%. What is the one-year forward rate 2 years from now

Answer 1

13.90%

Step-by-step explanation:

Mathematically, the relationship between the different interest rates using the equation is shown below:

(1+S3)^3=(1+S2)^2*(1+2y1y)

The spot rate in year 3 is the same as the spot rate in year 2 multiplied by the 1-year forward rate beginning 2 years.

S3=3-year rate =7.2%

S2=2-year rate =4%

2y1y=one-year interest rate 2 years from now=the unknown

(1+7.2%)^3=(1+4%)^2*(1+2y1y)

(1+2y1y) =(1+7.2%)^3/ (1+4%)^2

2y1y=(((1+7.2%)^3/ (1+4%)^2)-1

2y1y= 1.138984142 -1

2y1y= 13.90%