Liquidity premium implied by that forward rate

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Reference no: EM13814558

Suppose the short rate today is r1 = 6 percent while the expected short rate next year is E(r2) = 7 percent. Suppose Ann is a short-term investor whose goal is to have $2,000 next year. To do that, she chooses between 1 and 2-year maturity zeros. Find what Ann would be willing to pay for the 2-year maturity zero under the Expectations Hypothesis. It turns out that Ann is willing to invest in the 2-year zero only if its price were $1,731. Find the risk premium Ann is demanding from the 2-year zero. Find the yield to maturity on the 2-year zero selling at $1,731. Find the forward rate f2 and the Liquidity premium implied by that forward rate.

Reference no: EM13814558

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