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Suppose the price of the 3-year zero coupon bond is $800 and the 6-year zero bond is $600 How could you lock the 3-year borrowing rate starting at the end of year 3? Transaction Time=0 Time=3 Time=6 What is the implied forward rate on a 3- year bond which will start at the end of year 3 According to the liquidity premium theory of the term structure
Suppose the price of the 3-year zero coupon bond is $800 and the 6-year zero bond is $600
- How could you lock the 3-year borrowing rate starting at the end of year 3?
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- What is the implied forward rate on a 3- year bond which will start at the end of year 3
- According to the liquidity premium theory of the term structure. What is the expected rate on a 3-year bond at the end of year 3?
Expert Solution
Rate of 3 year zero coupon bond is
800 = 1000/(1+r)3
r = 7.72%
Rate of 6 year Zero Coupon Bond is
600 = 1000/(1+r)6
r = 8.89%
Rate of 3 year zero coupon bond after 3 year is
(1+8.89%)6 = (1+7.72%)3 x (1+R)3
1.66697 = 1.24994 x (1+R)3
(1+R)3 = 1.33364
R = 10.07%
Forward rate on a 3- year bond which will start at the end of year 3 is 10.07%
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