You want to decide whether to invest in zero-coupon bonds or not. currently, the yield to maturity of these zero-coupon bonds for the one-year is 8% and for the two-year is 9%. given this information what is the forward rate of interest for the second year?
a. 10.01%
b. 8%
c. 9.2%
d. 3.25%

The forward rate of interest for the second year is;

a. 10.01%

Explanation:

Step 1: Determine the 1 year final value of the investment

The formula for calculating the final value for the 1 year investment is;

F.V=P.V(1+r)

where;

F.V=final value

P.V=present value

r=yield to maturity

In our case;

F.V=unknown

P.V=x

r=8%=8/100=0.08

replacing;

F.V=x(1+0.08)=1.08 x

Step 2: Determine the 2 year final value of the investment

Using the formula;

F.V=P.V(1+r)²

where;

F.V=unknown

P.V=x

r=9%=9/100=0.09

replacing;

F.V=x(1+0.09)²=1.1881 x

Step 3: Determine the forward rate of interest for the second year

The forward rate of interest can be expressed as;

forward rate of interest=(2-year future value/1-year future value)-1

replacing;

forward rate of interest=(1.1881 x/1.08 x)-1=0.10009×100=10.01%

forward rate of interest=10.01%

cash flow statement possibly

if you use only 25 for your entertainment and only 200 for the groceries that you really need and take out the 50 per month for the computer then that should be enough