# Chap6A - What are the forward rates over each of the 3...

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Questions and Problems - Appendix to Chapter 6 6A.3 Investors set interest rates such that the forward rate over a given period equals the spot rate expected by the market for that period. 6A.4 The liquidity-preference hypothesis maintains that investors require a risk premium for holding longer-term bonds (i.e. they prefer to be liquid or short-term investors). This implies that the market sets the forward rate for a given period above the expected spot rate for that period. 6A.6 a. (1 + r 6 ) 6 = ( 1 + r 5 ) 5 ( 1 + ƒ 6 ) (1 + r 6 ) 6 = ( 1.07) 5 (1.0521) r 6 = 6.7% b. (1 + r 5 ) 5 = ( 1 + r 4 ) 4 ( 1 + ƒ 5 ) ( 1.07) 5 = ( 1 + r 4 ) 4 (1.068) r 4 = 7.05% 6A.7 a. P = \$60 / 1.09 + \$1,060 / (1.10) 2 = \$55.05 + \$ 876.03 = \$931.08 b. \$931.08 = \$60 / ( 1 + y ) + \$1,060 / ( 1 + y ) 2 y = YTM = 9.97% 6A.8 P = \$50 / 1.09 + \$1,050 / (1.07) 2 = \$45.87 + \$917.11 = \$962.98 6A.9 ( 1 + r 1 )( 1 + ƒ 2 ) = ( 1 + r 2 ) 2 ( 1.08 ) ( 1 + ƒ 2 ) = ( 1.09 ) 2 ƒ 2 = .1001 6A.10 The last line of the question, below the table should be:

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Unformatted text preview: What are the forward rates over each of the 3 years? ( 1 + r 2 ) 2 = ( 1+ r 1 ) ( 1 + 2 ) ( 1.06 ) 2 = ( 1.04 )( 1 + 2 ) 2 = .0804, one-year forward rate over the 2 nd year is 8.04%. ( 1 + r 3 ) 3 = ( 1 + r 2 ) 2 ( 1 + 3 ) ( 1.10 ) 3 = ( 1.06 ) 2 ( 1 + 3 ) 3 = .1846, one-year forward rate over the 3 rd year is 18.46%. 6A.11 a. \$900.00 = \$1,000/(1+r 1 ) r 1 = 11.11% \$812.00 = \$1,000/(1+r 2 ) 2 r 2 = 10. 97% \$693.18 = \$1,000/(1+r 3 ) 3 r 3 = 12.99% b. 2 = [(1 + r 2 ) 2 / ( 1 + r 1 )] -1 Answers to End-of-Chapter Problems B-41 = [(1+0.1097) 2 / (1+0.1111)] 1 = 10.83% 3 = [(1 + r 3 ) 3 / ( 1 + r 2 ) 2 ] -1 = [(1 + 0.1299) 3 / (1 + 0.1097) 2 ] -1 = 17.14% 6A.12 a. According to the expectations hypothesis, its expected price is \$1,000/ (1+0.1714)= \$853.68 Answers to End-of-Chapter Problems B-42...
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## This note was uploaded on 11/02/2011 for the course ACTSC 371 taught by Professor Wood during the Fall '08 term at Waterloo.

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Chap6A - What are the forward rates over each of the 3...

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