Assuming away any risk differential of investing in a two-year security for two years or a on-year security followed by another one-year security during year two, we can calculate the one-year...

Assuming away any risk differential of investing in a two-year security for two years or a on-year security followed by another one-year security during year two, we can calculate the one-year interest rate expected by market investors next year For example, if a two-year security offers an annual interest rate of 6% for each of two years and a one-year security offers an annual interest rate of 5%, the one year rate one year from today impounded in the two-year rate must be 7%. In other words, if an investor in a two-year security earns 65 for each of two years, the investor will earn 12% over the two year period -- assuming away the affect of compounding (interest on Interest) Since we are assuming a strategy of investing in a one-year instrument followed by another one-year instrument is equal in risk to investing in a two-year instrument for two years, the average annual return of the two sequential one-year securities must also sum to 12%. Given that a one-year security currently offers 5%, a one-year security one year from today must be expected to offer a one-year rate of 7% to yield the same average annual return over a two year period equivalent to that offered by a similar risk investment in a two-year security for two years. Understanding the above, determine the market's expected one-year rate one year from today when a one-year security today offers an interest rate of 3.5% and a two-year security offers an interest rate of 4.2% (state your solution to the nearest one-tenth of one percent: x.x%) If you could provide TI-84 plus instructions as well, please!
Jun 08, 2022
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