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Unformatted text preview: THE EXPECTATIONS APPROACH T O THE TERM STRUCTURE THE FORWARD INTEREST RATE [p.552): t+krn.t : the expected interest rate - where n is the term to maturity of the security, t is the point in time at which the expectations are held, and t+k is the beginning of the period a t which the interest rate becomes applicable. THE 'SPOT' RATE 1p.5521: r,,, : the actual interest rate prevailing a t time period t, for a security with n periods o r 'years' to maturity. These latter rates are observable, known data. THE ZERO-PROFITABLE-ARBITRAGE OR EQUI- PROFITABILITY CONDITION lp.5521: (1+r2,,)(l+r2,,) = (l+rl,t)(l+t+lrl,~ [J&amp;H equation 131 SUPPOSE INITIALLY r,,, = r,,, . THEN EQULIBRIUM REQUIRES: AND THEREFORE: That is to say, the actual one-'year' or one-period rate in period one is expected to prevail also (or to remain the same) in period two: 'short' rates are expected to remain constant, and therefore 'long' rates equal 'short' rates....
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This note was uploaded on 04/20/2010 for the course ECOF 3001 taught by Professor - during the One '09 term at University of Sydney.
- One '09