2
$\begingroup$

You are given the following information regarding the domestic government fixed-interest bond market:

  • The current price of a one-year bond paying coupons at a rate of $4.5$% per annum and redeemed at par is £100.41 per £100 nominal
  • The current price of a two-year bond paying coupons at a rate of $6.5$% per annum and redeemed at par is £100.48 per £100 nominal

Calculate the two-year spot rate of interest, $y_2$

I'm not sure how to start this question. Do we have to work out the first and second year forward rates?

$\endgroup$
2
  • 1
    $\begingroup$ Is this a homework assignment? You posted a similar plea on Math.SE. $\endgroup$ Apr 18, 2013 at 19:23
  • $\begingroup$ It's a practice question in one of the tutorial sheets, not a homework assignment. They have only given the answer of the question but I do not know how to solve it. $\endgroup$ Apr 18, 2013 at 22:13

1 Answer 1

0
$\begingroup$

Solving for annual interest rates:

The one year annual spot rate r1: $$ 1.045/(1+r1)=1.0041 => r1 \approx 4.0733\% $$ The one-two year forward rate r1,2: $$ .065/(1+r1)+1.065/(1+r1)(1+r1,2)=1.0048 => r1,2 \approx 8.5927\% $$ The two year spot rate r2= $$ (1+r2)^{2}=(1+r1)(1+r1,2) => r2 \approx 6.3090\% $$

$\endgroup$
0

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

Not the answer you're looking for? Browse other questions tagged or ask your own question.