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One-year interest rates over the next five years are expected to be as follows: 5%, 9%, 10%, 15%, 16 Assuming the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curve
One-year interest rates over the next five years are expected to be as follows: 5%, 9%, 10%, 15%, 16 Assuming the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curve.
Expert Solution
s per expectations theory future interest rate is dependent upon short term interest rates.
Hence forward interest rates are calculated below:
| Year | One year interest rate | Interest rate for cumulative period | Calculation |
| 1 | 5% | 5.00% | |
| 2 | 9% | 6.98% | ((1.05)*(1.09))^(1/2)-1 |
| 3 | 10% | 7.98% | ((1.05)*(1.09)*(1.1))^(1/3)-1 |
| 4 | 15% | 9.69% | ((1.05)*(1.09)*(1.1)*(1.15))^(1/4)-1 |
| 5 | 16% | 10.93% | ((1.05)*(1.09)*(1.1)*(1.15)*(1.16))^(1/5)-1 |
Yield curve will look like this:
please see the attached file for the complete solution.
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