Firm needs 2 mill from now. How does it borrow at today's interest rates if it does not need these funds for two years, and then only one yer loan. What rate will firm pay on one year loan?
It would sell 1 million in three year bonds. Comp would buy $q1 mill in two year bonds. For the first two years it would pay out interest on two year bond it owns to cover for int on bond it sold. End of second year, bond matures, firm has $1 mill. End of third year it must pay back hilders of three year bond. Determined by i sub n