11. 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%. What arbitrage opportunity is available for an investment banking firm?

What is the profit on the activity?

12. Suppose that a 1-year zero-coupon bond with face value $100 currently sells at $94.34, while a 2-year zero sells at $84.99. You are considering the purchase of a 2-year-maturity bond making annual coupon payments. The face value of the bond is $100, and the coupon rate is 12% per year.

a. What is the yield to maturity of the 2-year zero? The 2-year coupon bond?

b. What is the forward rate for the second year?

c. If the expectations hypothesis is accepted, what are (1) the expected price of the coupon bond at the end of the first year and (2) the expected holding-period return on the coupon bond over the first year?

d. Will the expected rate of return be higher or lower if you accept the liquidity preference hypothesis?