Look back at our example in Section 24.4 of the short-, medium-, and long-term bonds. Remember that

Question:

Look back at our example in Section 24.4 of the short-, medium-, and long-term bonds. Remember that we said that the prices must stand in a particular relationship or there would be an arbitrage opportunity. This means that we can take advantage of the risk answer the following questions:

(a) Suppose that the price of the short bond is 98 and the price of the medium is 83. What is the price of the long bond?

(b) What are the possible future prices of these three bonds at the end of three months if rates rise and if they fall?

(d) What is the probability of an interest rate rise?

(e) Show that the expected return on each bond is equal.

Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...