Suppose the following table shows yields to maturity of zero coupon U.S. Treasury securities as of January 1, 1996:
|
Term to Maturity (Years) |
Yield to Maturity |
|
1 |
3.50% |
|
2 |
4.50 |
|
3 |
5.00 |
|
4 |
5.50 |
|
5 |
6.00 |
|
10 |
6.60 |
a. Based on the data in the table, calculate the implied forward 1 year rate of interest at January 1, 1999.
b. Describe the conditions under which the calculated forward rate would be an unbiased estimate of the 1 year spot rate of interest at January 1, 1999.
c. Assume that 1 year earlier, at January 1, 1995, the prevailing term structure for
U.S. Treasury securities was such that the implied forward 1 year rate of interest at January 1, 1999, was significantly higher than the corresponding rate implied by the term structure at January 1, 1996. On the basis of the pure expectations theory of the term structure, briefly discuss two factors that could account for such a decline in the implied forward rate.