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Bank purchases a $100 zero-coupon bond with 2 years to maturity at $80,44. This means YTM = 11,5%. Market yield on 1-year bonds is 10%
Bank purchases a $100 zero-coupon bond with 2 years to maturity at $80,44. This means YTM = 11,5%. Market yield on 1-year bonds is 10% and forecast for next years 1-year rate is that rates will rise to either 13,82% (scenario A) or 12.18% (Scenario B). The two scenarios are equally probable. To limit their risks, Bank decides to buy an European put on the bond with strike price $88,60 and maturity of 1 year from now.
- If Bank need to sell the bond after 1 year from now what are the two possible bond price under each of the scenarios?
- What is the expected price of the bond after 1 year from now?
- What is the maximum value of the put 1 year from now, given only the two scenarios are possible?
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