The interest rates in the table below were taken from the Bank of Canada zero coupon yield curve for November 15, 2022. For the purposes of this problem, suppose that is today's date and that zero coupon bonds trade at these yields. Yields are compounded semi-annually.

 

Canadian Zero-coupon yields:

Maturity	Yield
2023 Nov 15	4.441%
2024 Nov 15	3.802%
2025 Nov 15	3.589%
2026 Nov 15	3.393%
2027 Nov 15	3.234%

a.) What are 1, 2, 3, 4, and 5-year spot rates today? 

b.) You believe interest rates at all maturities will decrease by 0.20% over the next year. If you have a two-year investment horizon and care only about your expected payoff, should you: (i) buy a 2-year zero coupon bond today and hold it for two years, or (ii) buy a 1-year zero coupon bond today and, when it matures, roll it over into a new 1-year strip?

c.) What is the breakeven (forward) rate between the two investment strategies in part (b)? According to the Expectations Hypothesis, what does today's market expect the new 1-year interest rate to equal on Nov 15, 2023?

d.) According to the Expectations Hypothesis, what does today's market expect the new 1-year interest rate to equal on Nov 15, 2024?

Answer rating: 100% (QA)

A The 1 2 3 4 and 5year spot rates today are 4441 3802 3589 3393 an... View the full answer