Calculate interest rates in term structure for maturities

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Reference no: EM132053259

If one-year interest rates for the next five years are expected to be 5%, 3%, 6%, 5% and 5%

A. Assuming the expectation theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves.

B. In fact, most investors are risk-averse, so they tend to prefer shorter-term bonds because these bonds bear less interest-rate risk. For this reason, investors must be offered a positive liquidity premium to induce them to hold longer-term bonds. Suppose that the liquidity premium ln follows

ln =(n?1)×rf,

where n is the terms to maturity and rf is the risk-free interest rate which is determined in the Treasury Bond market. For simplicity, we assume that rf = 1.1%. Please calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves.

Reference no: EM132053259

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