Suppose we observe the following rates: 1 R 1 = 4%, 1 R 2 = 5%. If the unbiased
ID: 2735701 • Letter: S
Question
Suppose we observe the following rates: 1R1 = 4%, 1R2 = 5%. If the unbiased expectations theory of the term structure of interest rates holds, what is the 1-year interest rate expected one year from now, E(2r1)?(Do not round intermediate calculations and round your answer to the nearest whole percent.)
Suppose we observe the following rates: 1R1 = 4%, 1R2 = 5%. If the unbiased expectations theory of the term structure of interest rates holds, what is the 1-year interest rate expected one year from now, E(2r1)?(Do not round intermediate calculations and round your answer to the nearest whole percent.)
Explanation / Answer
The 1-year interest rate expected one year from now =[ (1 + 0.05)2 / (1 + 0.04)1 - 1 ]
The 1-year interest rate expected one year from now = [ (1.05)2 / (1.04) - 1 ]
The 1-year interest rate expected one year from now = [ 1.1025 / 1.04 - 1 ]
The 1-year interest rate expected one year from now = [ 1.060 - 1]
The 1-year interest rate expected one year from now = 0.06 Or 6 %.
Conclusion:- The 1-year interest rate expected one year from now = 6 %.