What are the implied one-year forward rates? ( Do not round intermediate calcula

Question

What are the implied one-year forward rates? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Assume that the pure expectations hypothesis of the term structure is correct. If market expectations are accurate, what will the pure yield curve (that is, the yields to maturity on one- and two-year zero-coupon bonds) be next year?

If you purchase a two-year zero-coupon bond now, what is the expected total rate of return over the next year? (Hint: Compute the current and expected future prices.) Ignore taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

If you purchase a three-year zero-coupon bond now, what is the expected total rate of return over the next year? (Hint: Compute the current and expected future prices.) Ignore taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

a)

Implied one-year forward rate is as follows:

1 year forward rate for 1 year, r:

(1+r)×(1+9.1%) = (1+10.1%)^2

1 year forward rate one year from now = 11.1%

1 year forward rate for 2 years, r:

(1+r)^2×(1+9.1%) = (1+11.1%)^3

2 year forward rate 1 year from now, r = 12.11%

b)

There will be a shift upwards in next year's curve.

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