Question
An investor is considering the purchase of zero-coupon bonds with maturities of one, three, or five years. Currently the spot rates for 1-, 2-, 3-,
An investor is considering the purchase of zero-coupon bonds with maturities of one, three, or five years. Currently the spot rates for 1-, 2-, 3-, 4-, and 5-year zero-coupon bonds are, respectively, 0.031, 0.035, 0.04, 0.042, and 0.043 per year with semi-annual compounding. A financial analyst has advised this investor that interest rates will increase during the next year and the analyst expects all spot rates to increase by the amount 0.005, so that the one-year spot rate will become 0.03, and so forth. The investor plans to sell the bond at the end of one year and wants the greatest return for the year. (a) What are the current prices of 1-, 3-, and 5-year zero-coupon bonds with par values of $1000? (b) What will be the prices of these bonds one year from now if spot rates remain unchanged? (c) What will be the prices of these bonds one year from now if spot rates each increase by 0.005?
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