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Assume that the assumptions of the Expectations Hypothesis are true and that today's one-year risk-free rate is 7%. Moreover, investors expect that the one year rate one year from now will be 8% and the one year rate two years from now will be 9%. Given this information, what should be today's two-year and three-year risk-free rates? Be precise with lots of decimals on your calculator!

Respuesta :

TomShelby

Answer:

for    two-years: 7.4988372%

for three years: 7.9969135%

Explanation:

the expectation theroy assumes the two year and three year rate will yield the same amount as th expected investment

thus the two-year rate will equivalent to 7% for the first year and then, the expected 8%

[tex](1+0.7)(1.08)=(1+r_{two-year})^2[/tex]

for two-years: 0.074988372 = 7.4988372%

for three years:

[tex](1.07)(1.08)(1.09) = (1 + r_{three-years})^3[/tex]

r3 = 0.079969135