Suppose that 1-year coupon bonds pay 3.25% per year, 2-year coupon bonds pay 3% per year, and 3-year coupon bonds pay 2.75% per year. Assume that the risk premium for the 1 year bond is 0.25%, increasing by 0.25% for each additional year of maturity. What are the expected risk-adjusted interest rates for a:
A ) 1-year bond purchased in one year
B ) 1-year bond purchased in two years
C ) Yield curve for all three bonds (% yield per bond)
My answers:
The formula I used was: i(n)t = 1/n [Exi (t+n-1)] + RP. This got me:
A ) i(n)t = 1/1 [0.0325(1+1-1)] + 0.25 = 3.5%
B ) i(n)t = 1/2 [0.0325(2+1-1)] + 0.25 = 3.5%
C ) I don't know how to incorporate my given information into this question.
Not sure if I'm interpreting the question correctly. Please help.
This post was edited by Jays on Oct 24 2017 07:08pm