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Term Structure of Interest Rates

Suppose the current one-year interest rate is 6%. One year from now, you believe the economy will start to slow and the one-year interest rate fell to 2%. The one-year interest rate will then rise to 3% the following year, and continue to rise by 1% per year until it returns to 6%, where it will remain from then on.
a. If you were certain regarding these future interest rate changes, what two-year interest rate would be consistent with these expectations?
b. What current term structure of interest rates, for terms of 1 to 10 years, would be consistent with these expectations?
c. Plot the yield curve in this case. How does the one-year interest rate compare to the ten-year interest rate?

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Solution Preview

** The answers are in the attached Excel file **

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Suppose the current one-year interest rate is 6%.  One year from now, you believe the economy will start to slow and the one-year interest rate fell to 2%.  The one-year interest rate will then rise to 3% the following year, and continue to rise by 1% per year until it returns to 6%, where it will remain from then on.

a. If you were certain regarding these future interest rate changes, what two-year interest rate would be ...

Solution Summary

Calculates interest rates for different maturities.

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