Chapter 5, Problem 11PROB

Summary Introduction

Expectation theory:

Expectation theory is used to find forward interest rate based on the prevailing long term interest rates.

Calculate the forward rate as follows:

$\text{Forward rate}=\left(\left({\text{N}}^{\text{th}}\text{year}\times {\text{N}}^{\text{th}}\text{year interest rate}\right)-\left({\left(\text{N-1}\right)}^{\text{th}}\text{year}\times {\left(\text{N-1}\right)}^{\text{th}}\text{year interest rate}\right)\right)$

Given two year Treasury bond rate is 1.2%, three year Treasury bond rate is 1.4% and four year Treasury bond rate is 1.9%.