Question

Prices of zero-coupon bonds reveal the following pattern of forward rates: Year Forward Rate 1 6%...

Prices of zero-coupon bonds reveal the following pattern of forward rates:
Year Forward Rate
1 6%
2 7   
3 8   

   

In addition to the zero-coupon bond, investors also may purchase a 3-year bond making annual payments of $60 with par value $1,000.

  

a.

What is the price of the coupon bond?(Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)

  

  Price $   

  

b.

What is the yield to maturity of the coupon bond? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

  

  Yield to maturity %  

  

c.

Under the expectations hypothesis, what is the expected realized compound yield of the coupon bond? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

  

  Realized compound yield %  

   

d.

If you forecast that the yield curve in 1 year will be flat at 8.0%, what is your forecast for the expected rate of return on the coupon bond for the 1-year holding period? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "%" sign in your response.)

  

  Holding period return %  

Homework Answers

Answer #1

a.

Cash Flows 60 60 1060
Forward Rate 6% 7% 8%
Present value 56.60377 52.90072 865.3513
Price $                                             974.86

b.

YTM=[ C+((F-P)/n)] / [(F+P)/2]
Where,
C= Coupon Rate
F= Face Value
P= Price
Ytm= 6.93%

c.

Expected Compounded Yield= (1.06x1.07x1.08)-1
= 22.49%

d.

Expected Rate of return by holding bond for 1 year= (Price of bond at end of 1st year - Price of bond today + Coupon) / Price of bond today

= (964.33*-974.86+60)/974.86 = 5.08

* price of bond after 1 year

Cash Flows 60 1060
Forward Rate 8% 8%
Present value 55.55556 908.7791
Price $ 964.33
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