Question #56
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 22
Status: Unattempted
Correct Answer: A
Question
Which of the following most accurately explains the "break-even-rate" interpretation of forward rates? The forward rate is the rate that will make an investor indifferent between investing:
Answer Choices:
A. investing at the spot or forward interest rate
B. now or at a forward time
C. for the full investment horizon, or for part of it, and then rolling over the proceeds for the balance of the investment horizon at the forward rate
Explanation
The pure expectations theory can be explained using a "break-even rate" line of reasoning.
The break-even rate is the forward rate that leaves investors indifferent between investing
for the full term of their investment horizon or investing in part of the horizon and rolling
the investment over at the "break-even" forward rate for the remainder of the term.