Question 3

(a) The S&P/ASX200 price index opened the year at 7,200 and was at 7,683 by the end of the year. TheS&P/ASX Small Ordinaries index went from 2,800 to 3,222 over the same period. What is the effective annual rate of return on each of these indices? Explain the difference in information provided by these two indices.

(b) Using the approach covered in your textbook calculate the geometric average annual forward rates of return out to five years given the following annual spot rates, one year (0i1 = 0.65%), two year (0i2 = 0.75%), three year (0i3 = 0.84%), four year (0i4 = 0.92%), five year (0i5 = 0.99%). What does this imply about future interest rates.?

(Rates as a percentages accurate to one basis point)