Problem:

The Fed is concerned with interest rate levels and the possibilitiy of inflation. Given the gollowing information, calculate the expected inflation premiums over hte next three years. Should the FED be concerned with inflation in the near term (first year), interim period (second year), or longer term (third year) period observed?

Required:

Question 1) Using the January 2012 data, calculate the two annual forward rates using the information provided below.

Question 2) Calculate the expcted inflation rates for each of the next three years (if the real rate is 2% using the spt given and forward rates calculated.

Question 3) Draw the two yield curves on the same graph - label each. Using the Rates provided for September 2010, how has the yield curve change since 2010 to 2012? What does the change imply? (I'm sure this cannot be drawn in this site,  but a description would help)

September 2010

Date      1 mon     3 mon     6 mon     1 yr    2 yr     3 yr     5 yr      7 yr      10 yr     20 yr   30 yr

9/29/10   .12         .16         .20        .27     .44     .67      1.28     1.91     2.52      3.38     3.69

January 2012

Date       1 mon     3 mon     6 mon     1 yr    2 yr     3 yr     5 yr      7 yr     10 yr     20 yr     30 yr

1.13.12    .02        .03          .06        .10     .24     .34       .80      1.32     1.89      2.59      2.91

Solve the given numerical problem and illustrate step by step calculation.