Describe the conditions under which the calculated forward rate would be an unbiased estimate of the… 1 answer below »

CFA Examination Level II

The following table shows yields to maturity on U.S Treasury securities as of January 1, 1993:

Term to Maturity

Yield to Maturity

1 year

3.50%

2 years

4.50%

3 years

5.00%

4 years

5.50%

5 years

6.00%

10 years

6.60%

a. Based on the data in the table, calculate the implied forward one-year rate of interest at January 1, 1996.

b. Describe the conditions under which the calculated forward rate would be an unbiased estimate of the one-year spot rate of interest at January 1, 1996.

Assume that one year earlier, at January 1, 1992, the prevailing term structure for U.S. Treasury securities was such that the implied forward one-year rate of interest at January 1, 1996, was significantly higher than the corresponding rate implied by the term structure at January 1, 1993.

c. 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.

Multiple scenario forecasting frequently makes use of information from the term structure of interest rates. d. Briefly describe how the information conveyed by this observed decrease in the implied forward rate for 1996 could be used in making a multiple scenario forecast.