1. Suppose that one-year zero-coupon US Treasury bonds with a $10,000 face value are currently selling for $9,852. Similarly zero-coupon Treasuries with two years to maturity are selling for $9,481 and those with five years to maturity are selling for $8,339.

1. What are the yields on these three bonds?

2. Following three months of very good economic news, the yields on 1-year, 2-year, and 5-year

bonds have risen to 2.7%, 3.8%, and 4.5% respectively. If the Treasury were looking to issue new zero-coupon, $10,000 face value bonds with 1, 2, and 5 year maturities, at what prices would you expect them to sell for?

2. Two bonds have a face value of $1,000 and a maturity of two years. One pays a yearly coupon of $200, whereas the other pays a yearly coupon of $50.

a. If the market interest rate is 8 percent, what will be the prices of the two bonds?

b. If inflation suddenly causes the interest rate to rise to 20 percent, what will be the new prices for the two bonds?

c. Which bond suffers a greater percentage decrease in its price when the interest rate rises? Why?

d. Suppose interest rates suddenly decline to 5 percent. What will be the new prices of the two bonds?

e. With returns at 8 percent, what is the future value of the cash flows from the two bonds? That is, how much money will you have in two years from each of the bonds, taking into account reinvestment of your coupon income at 8 percent for two years plus your final principal repayment at maturity?

f. Suppose the maturities of the two bonds are extended to 10 years. What will be the prices of the two bonds given a required yield of 8 percent?