Suppose you have the following yield curve (i.e., YTMs for the following zero-coupon bonds): Yrs. To...

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Suppose you have the following yield curve (i.e., YTMs for the following zero-coupon bonds): Yrs. To Maturity 1 2 3 4 5 YTM 6.20% 5.05% 5.50% 5.75% 6.25% Price $941.62 $906.17 $851.61 $799.61 $738.51 Part A (2 marks): What is the one-year forward rate, starting three years from now? Part B (3 marks): Under the expectations hypothesis, what is the expected one-year interest rate starting in three years? Start by stating the expectations hypothesis (in one sentence). | Part C (3 marks): Suppose the annual liquidity premium is 0.50% (LP₂ = 0.5%). What is the expected one-year interest rate starting in three years under the liquidity preference theory? Start by stating the liquidity preference theory (in one sentence). Part D (4 marks): Suppose that you want to construct a one-year loan starting four years from now. What positions would you take today? Show all relevant cash flows and compute the rate you lend at. Hint: i) this will involve the 5-year bond and the 4-year bond, ii) to determine which bond you long and which bond you short, think about which period you want a cash inflow, iii) to determine the amounts you trade, remember th time zero cash flow must be zero. Suppose you have the following yield curve (i.e., YTMs for the following zero-coupon bonds): Yrs. To Maturity 1 2 3 4 5 YTM 6.20% 5.05% 5.50% 5.75% 6.25% Price $941.62 $906.17 $851.61 $799.61 $738.51 Part A (2 marks): What is the one-year forward rate, starting three years from now? Part B (3 marks): Under the expectations hypothesis, what is the expected one-year interest rate starting in three years? Start by stating the expectations hypothesis (in one sentence). | Part C (3 marks): Suppose the annual liquidity premium is 0.50% (LP₂ = 0.5%). What is the expected one-year interest rate starting in three years under the liquidity preference theory? Start by stating the liquidity preference theory (in one sentence). Part D (4 marks): Suppose that you want to construct a one-year loan starting four years from now. What positions would you take today? Show all relevant cash flows and compute the rate you lend at. Hint: i) this will involve the 5-year bond and the 4-year bond, ii) to determine which bond you long and which bond you short, think about which period you want a cash inflow, iii) to determine the amounts you trade, remember th time zero cash flow must be zero.

Answer rating: 100% (QA)

Part A The oneyear forward rate starting three years from now can be calculated using the formula Forward Rate 1 YTMnn 1 YTMn1n1 1 where YTMn is the y... View the full answer