Interest Rates

1. Under the pure expectation theory, when 1 year maturity yield 6.0%, 2 years maturity yield 6.2%, 3 years maturity yield 6.4%, 4 years maturity yield 6.5%, 5 years maturity yield 6.5%, what is the interest on two years security, three years from now, the forward rate: i 3,2)? (Hint: use the forumula (1+i m+n)^(m+n)=(1+i m)^m+(1+ i m,n)^n)2. Ms. Sharon Corporation has 5-year bonds. Inflation premium (IP) on a 5year bond is 1.00%. The real risk-free rate is r* = 2.80%, the default risk premium for her bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on her bonds is LP = 1.20%, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) x 0.1%, where t = number of years to maturity. What is the yield on her Corporation’s 5-year bonds?

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