Consider the bond market to be in equilibrium according to our complete theory of the term structure of interest rates. The current interest rate on one-year bonds is 5 percent, and you believe, as does everyone in the market, that in one year the interest rate on one-year bonds will be 6 percent and in two years the interest rate on one-year bonds will be 6.5 percent. Assume that there is no term premium on a one-year bond. Suppose the term premium equals 0.5 percent ´ the number of years to maturity, for two-year bonds and three-year bonds. The interest rate today on the two-year bond is ____ and the interest rate today on a three-year bond is ____.

Select one:

a. 5.5 percent; 5.8 percent

b. 6.0 percent; 6.3 percent

c. 6.2 percent; 6.8 percent

d. 6.5 percent; 7.3 percent

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To calculate the interest rate as per theory of the term structure of interest rates ... View the full answer