Question

Given the following spot rates on CDs: 1-year CD: 3% 2-year CD: 6% 4-year CD: 7% 5-year CD: 8% find the interest rate on 1-year CDs, 4 years forward. Express your answer as a percentage with three digits after the decimal point. Do NOT enter the percentage sign (%).

Answer 1

7.935%

Step-by-step explanation:

The computation of the interest rate on 1-year CDs, 4 years forward is shown below:

We Use expectation theory in this question which is

(1 + year 5 CD rate)^number of years = (1 + year 4 CD rate)^number of years × (1 +1 year four year forward rate )

(1 + 5.5%)^5 = (1 + 4.9%)^4 × (1 + year 1 four year forward rate)

1.3069600064 = 1.2108823608 ×(1 + 1 year rate four year forward rate)

So, 1 year four rate forward rate is 7.935%