Solution Below is a set of current t prices on a set of zero coupon bonds The face value on all of these

Solution Below is a set of current t prices on a set of zero coupon bonds The

of current t prices on a set of zero coupon bonds The face value on all of these bonds is The prices below are quoted

Solution Below is a set of current t prices on a set of zero

coupon bonds The face value on all of these bonds is The prices below are quoted

Solution Below is a set of current t prices on a

Solution Below is a set

Category: | General |

Words: | 1050 |

Amount: | $12 |

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Paper instructions

Please see attachedPlease see attachedPlease see attached1
Below is a set of current (t = 0) prices on a set of zero-coupon bonds. The face value on all of
these bonds is $1000. The prices below are quoted per $1000 in face value. In answering the
following ques±ons, assume that you can buy frac±ons of a bond.
Bond
Price
1-year zero
950
2-year zero
900
3-year zero
860
4-year zero
790
Also assume, for simplicity, that each of these bonds matures in exactly a mul±ple of a year
from now (now = t = 0)
1.
If you invested in a two-year bond and rolled over into a one-year bond at t = 2, what
would the one-year yield at t = 2 have to be in order for you to be indiFerent between
that strategy and inves±ng in the three-year bond at t = 0?
²or the next set of ques±ons, consider the following: You have $20,000 and want to make an
investment that will allow you to have a down payment on a house in exactly two years.
Consider the following two alterna±ve strategies:
a.
You can invest in the default-free 3-year zero-coupon bond and sell it a³er two years
(t = 2).
b.
You can invest in the default-free 2-year zero-coupon bond.
2.
Consider the ´rst strategy (i.e., strategy a) above.
a.
If the forward rates implied by the bond price data above turns out to be the
future rates that actually occur, what price (per $1000 in face value) will you get
at t = 2 for the 3-year bonds you are buying at t = 0? That is, what is the price of
these 3-year bonds in two years (at t = 2) from now (t = 0)?
b.
If the forward rates implied by the bond price data above turns out to be the
future rates that actually occur, what will be your holding period yield on the 3-
year bond you are buying at t = 0? That is, what is the internal rate of return on
the ´rst strategy (i.e., strategy a.)?

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