The one-year spot rate is currently 4%; the one-year spot rate one year from now

Question

The one-year spot rate is currently 4%; the one-year spot rate one year from now will be 3%; and the one-year spot rate two years from now will be 6%. Under the unbiased expectations theory, what must today's three-year spot rate be? Suppose the three-year spot rate is actually 3.75%, how could you take advantage of this? Explain.

Why does the size of the U.S. current account deficit put pressure on the value of the dollar to decline? How does the size of the capital account affect that pressure? Explain.

Explanation / Answer

First part=

One year spot rate=4%

One year spot rate from one year from now=3%

One year spot rate from two years from now=6%

So three year spot rate will be,

[1+(4/100)*1+(3/100)*1+(6/100)]-1

=0.04329*100=4.329%

As spot rate is actually 3.75% actually after 3 years so the spot rate is actually less so the only advantage we can take is by increasing forward contract so this will yield me arbitrage oppurtunity and riskless profit.

Second part:

The size of the U.S. current account deficit put pressure on the value of the dollar to decline as dollar(US currency) is totally dependent on the account as whole of the economy and it is directly proportional to capital.So greater the size of capital then there will be less pressure.

Please rate my answer first with 5 star ratings as i have answered both parts.!!

Good Luck.!!

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