(This problem illustrates “riding the yield curve,” which is covered in the appendix to this chapter.) The U.S. Treasury issues a ten-year, zero coupon bond.

a) What will be the original issue price if comparable yields are 6 percent? (Assume annual compounding.)

b) What will be the price of this zero coupon bond after three, six, and nine years have passed if the comparable yield remains 6 percent? What are the annualized returns the investor earns if the bond is sold after three, six, or nine years?

c) When the bond was issued, the structure of yields was as follows:

Years to Maturity Yield 1 3 4 4 7 5 10 6 What will be the price of the bond after three, six, and nine years have passed if this structure of yields does not change? What is the annualized return the investor earns if the bond is sold after three, six, or nine years?

d) Assume the structure of yields does change to the following:

Years to Maturity Yield 1 2 4 3 7 4 10 5 What will be the price of the bond after three, six, and nine years have passed? What is the annualized return the investor earns if the bond is sold after three, six, or nine years?

e) Assume the structure of yields changes to the following:
Years to Maturity Yield 1 4 4 5 7 6 10 7 What will be the price of the bond after three, six, and nine years have passed? What is the annualized return the investor earns if the bond is sold after three, six, or nine years?

f) Why are the annualized returns different in parts (b)–(e)?