Problem Set Interest Rates

Maturity Rate

1 year 5%

2 year 6%

5 year 8%

10 year 9%

1) Based on the above spot rates what is your forecast of the 1-year forward rate one-year from today? (Assume you are a proponent of the expectation hypothesis for problems 1 - 7)

2) Based on the above spot rates what is your forecast of the 3-year forward rate two years from today?

3) Based on the above spot rates what is your forecast of the 5-year forward rate five years from today?

4) Assume that the one-year spot rate is 4% and the 1-year forward rate one-year from today is 5.5% what is the 2-year spot rate?

5) Assume that the one-year spot rate is 4%, the 1-year forward rate one-year from today is 5.5%, and the one-year forward rate two years from today is 5.7%. What is the 3-year spot rate?

Maturity Rate

1 year 3%

2 year 6%

5 year 7%

8 year 7%

6) Based on the above spot rates what is your forecast of the 1-year forward rate one-year from today? (Assume you are a proponent of market segmentation theory.)

7) Based on the above spot rates what is your forecast of the 3-year forward rate five years from today?

8) Explain how the above answers would be impacted if you believed in the liquidity preference theory.