6 months 2%

12 months 6%

Assume semi-annual compounding and semi-annual coupon payment.

1. Calculate the prices of (1) 6-month zero coupon bond and (2) 12-month zero coupon bond. The par value is $1000 for both bonds.
2. An investor has an investment horizon of six months. She can invest her money in two ways. First, buy the 6-month bond and hold it until maturity. Second, buy the 12-month bond and sell it 6 months later. The investor expects that the spot rates will stay the same 6 months later. Which investment strategy would the investor choose if she prefers a higher expected holding period return?
3. The investor purchased the bonds at time zero. Six months later, the annualized spot rates are as follows:

6 months 19%

12 months 20%

Calculate the realized holding period return for both investment strategies. Is the 6-month bond risk-free? Is the 12-month bond risk-free? Explain.