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Homework answers / question archive / 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

Economics

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.

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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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