In: Finance
According to the expectations theory, what is the expected one-year treasury security rate (i.e. forward rate, f) three years from today if today’s rates on treasury securities of different maturities are as follows:
One-year US Treasury Note: 4.5%
Two-year US Treasury Note: 4.8%
Three-year US Treasury Note: 5.2%
Four-year US Treasury Note: 5.3%
Five-year US Treasury Note: 5.3%
1 Year after 3 year from Today Rate = [ [ (1 + YTM 4 ) ^ 4 / ( 1
+ YTM 3 ) ^ 3 ] ^ ( 1 / 1 ) ] - 1
= [ [ ( 1 + 0.053 ) ^ 4 / ( 1 + 0.052 ) ^ 3 ] ^ ( 1 / 1 ) ] -
1
= [ [ ( 1.053 ) ^ 4 / ( 1.052 ) ^ 3 ] ^ ( 1 / 1 ) ] - 1
= [ [ 1.2295 / 1.1643 ] ^ ( 1 / 1 ) ] - 1
= [ [ 1.056 ] ^ ( 1 / 1 ) ] - 1
= [ 1.056 ] - 1
= 0.056
= I.e 5.6 %
YTM 4 - Spot Rate for 4 Years
YTM 3 - Spot Rate for 3 Years
As requested forward Rate for Year 3:
1 Year after 2 year from Today Rate = [ [ (1 + YTM 3 ) ^ 3 / ( 1
+ YTM 2 ) ^ 2 ] ^ ( 1 / 1 ) ] - 1
= [ [ ( 1 + 0.052 ) ^ 3 / ( 1 + 0.048 ) ^ 2 ] ^ ( 1 / 1 ) ] -
1
= [ [ ( 1.052 ) ^ 3 / ( 1.048 ) ^ 2 ] ^ ( 1 / 1 ) ] - 1
= [ [ 1.1643 / 1.0983 ] ^ ( 1 / 1 ) ] - 1
= [ [ 1.06 ] ^ ( 1 / 1 ) ] - 1
= [ 1.06 ] - 1
= 0.06
= I.e 6 %