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Given the following term structure of risk-free interest rates today, what would you expect the interest rate to be on a two year bond three years from now? Enter your answer as a percent without the "%." Round your final answer to two decimals. Maturity in Years Interest Rate 1 3.00% 2 3.50% 3 3.75% 4 4.00% 5 4.00%

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TomShelby

Answer:

The bond will yield 4% per year

Explanation:

We have to look the bond return after three years:

year 1 will be the current year yieled

year 2 is 1 year ahead

year 3 is 2 year ahead

year 4 is three year ahead.

And from this rate we also consider the next rate as it is a two year bond:

[tex](1+r)^2 = 1.04 \times 1.04\\1 + r = \sqrt{1.0816}\\r = 1.04 - 1[/tex]

r = 0.04 = 4%

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