Question

The yield to maturity on one-year zero-coupon bonds is 7.4%. The
yield to maturity on two-year zero-coupon bonds is 8.4%.

**a.** What is the forward rate of interest for the
second year? **(Do not round intermediate
calculations.** **Round your answer to 2 decimal
places.)**

Forward rate of interest
%

**b.** If you believe in the expectations
hypothesis, what is your best guess as to the expected value of the
short-term interest rate next year? **(Do not round
intermediate calculations. Round your answer to 2 decimal
places.)**

Short-term interest rate %

**c.** If you believe in the liquidity preference
theory, is your best guess as to next year’s short-term interest
rate higher or lower than in (b)?

- | Lower |

-Higher |

Answer #1

a) Forward rate is nothing but spot rate + earnings as return from investing in two year maturity bond and holding to maturity

Thus,

(1+7.4%) * (1+ forward rate) = (1+8.4%)^2

1.074*(1+ forward rate) = 1.084^2

1.074*(1+ forward rate) = 1.17056

(1+ forward rate) = 1.17056/1.074

(1+ forward rate) = 1.094093

Forward rate = 1.094093-1

=9.4093%

b) Expectation hypothesis is proposition that the long term rate is determined purely by current and future expected short term rate, in such a way that the final value from investing in long term bond equals to value investing in short term bonds, Thus short term rate would be 9.4093%

c) Liquidity preference theory suggest that the investor will
demand higher interest rate for the bond offering more period of
fund blocking. Thus as per this theory next years short term
interest rate will be **lower** than in (b) as 2 year
interest rate is 8.4%

The yield to maturity on one-year zero coupon bonds is 4.98%.
The yield to maturity on two-year zero coupon bonds is 6.94%.
a. What is the forward rate of interest for the
second year? (Round your answer to 2 decimal
places.)
Forward rate
%
b. According to the expectations hypothesis,
what is the expected value of the one-year interest rate for next
year? (Round your answer to 2 decimal places.)
Expected value

Currently, the term structure is as follows: One-year bonds
yield 8.50%, two-year zero-coupon bonds yield 9.50%, three-year and
longer maturity zero-coupon bonds all yield 10.50%. You are
choosing between one, two, and three-year maturity bonds all paying
annual coupons of 9.50%. You strongly believe that at year-end the
yield curve will be flat at 10.50%.
a. Calculate the one year total rate of return for the three
bonds. (Do not round intermediate calculations. Round your answers
to 2 decimal places.)...

3. The yield to maturity on 1-year zero-coupon bonds is
currently 7%; the YTM on 2-year zeros is 8%. The Treasury plans to
issue a 2-year maturity coupon bond, paying coupons once
per year
with a coupon rate of 9%. The face value of the bond is
$100.
c. If the expectations theory of the yield curve is
correct, what is the market expectation of the price for which the
bond will sell next year?
d. Recalculate your answer to...

The yield to maturity (YTM) on 1-year zero-coupon bonds is 5%
and the YTM on 2-year zeros is 6%. The yield to maturity on
2-year-maturity coupon bonds with coupon rates of 8% (paid
annually) is 5.5%.
a. What arbitrage opportunity is available for an
investment banking firm?
b. What is the profit on the activity? (Do
not round intermediate calculations. Round your answer to 2 decimal
places.)

The yield to maturity (YTM) on 1-year zero-coupon bonds is 7%
and the YTM on 2-year zeros is 8%. The yield to maturity on
2-year-maturity coupon bonds with coupon rates of 11% (paid
annually) is 7.5%.
a. What arbitrage opportunity is available for
an investment banking firm?
The arbitrage strategy is to buy zeros with face values of
$ and $ , and respective maturities of one
year and two years.
b. What is the profit on the activity?
(Do not round...

The yield to maturity (YTM) on 1-year zero-coupon bonds is 5%
and the YTM on 2-year zeros is 6%. The yield to maturity on
2-year-maturity coupon bonds with coupon rates of 12% (paid
annually) is 5.8%.
a. What arbitrage opportunity is available for
an investment banking firm?
The arbitrage strategy is to buy zeros with face values of $____
and $____ , and respective maturities of one year and two
years.
b. What is the profit on the activity?
(Do...

The yield to maturity (YTM) on 1-year zero-coupon bonds is 7%
and the YTM on 2-year zeros is 8%. The yield to maturity on
2-year-maturity coupon bonds with coupon rates of 11% (paid
annually) is 7.5%.
a. What arbitrage opportunity is available for
an investment banking firm?
The arbitrage strategy is to buy zeros with face values of
$ and $ , and respective maturities of one
year and two years.
b. What is the profit on the activity?
(Do not round...

Prices of zero-coupon bonds reveal the following pattern of
forward rates:
Year
Forward Rate
1
8
%
2
11
3
13
In addition to the zero-coupon bond, investors also may purchase a
3-year bond making annual payments of $55 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.)
b. What is the yield to maturity of the coupon
bond? (Do not round intermediate calculations....

Prices of zero-coupon bonds reveal the following pattern of
forward rates:
Year
Forward Rate
1
6
%
2
7
3
9
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.)
b. What is the yield to maturity of the coupon
bond? (Do not round intermediate calculations....

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...

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