Compute the interest rates in 2020 on bonds

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Reference no: EM131220727

Suppose it is 2020 and the 1-year interest rate is 4 percent. The expected 1-year rates in the following four years (2021 to 2024) are 4 percent, 5 percent, 6 percent, and 6 percent.

a. Assume the expectations theory of the term structure, with no term premiums. Compute the interest rates in 2020 on bonds with maturities of 1, 2, 3, 4, and 5 years. Draw a yield curve.

b. Redo part (a) with term premiums. Assume the term premium for an n-year bond, tn, is (n/2) percent. For example, the premium for a 4-year bond is (4/2)% 2%.

Reference no: EM131220727

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