Below is a list of prices for zero-coupon bonds of various maturities.

Maturity (years)

Price of $1,000 Par Bond

(zero-coupon)

1 $943.40

2 873.52

3 816.37

a. An 8.5% coupon $1,000 par bond pays an annual coupon and will mature in three years.

What should the yield to maturity on the bond be?

b. If at the end of the first year the yield curve flattens out at 8%, what will be the 1-year

holding-period return on the coupon bond?

HAPTER IS : THE TERM STRUCTURE OF INTEREST RATES $109 10801 $100 . 92 12 . The current bond price is : (585 0.94340) + ( 585 087352) + 151 085 0.81637 ) = $1 040.20 This price implies a yield to maturity of 6 97 % as shown by the following ($85 x Annuity factor ( 6979 % , 3 ) + $1 000 * PV factor ( 697 % , 3) = $1 040.17 If one year from now y = 8% . then the bond price will be : ($85 x Annuity factor (8 % 2) + $1 000 PV factor (8 % 2) ) = $1 00892 The holding period rate of return is : 1585+ 151 008 92 - $1 040 20) $1 040 .20 = 0.0516 = 5.160 13 Forward Year Rate PV of SI received at period end 5% $1/105 50. 9524 1/ ( 105x107 50 .890 1/ ( 105 x 107 * 108 ) = 50 .8241 Price = ( 560 * 0. 9524 ) + ($60 * 0.8901 ) + (51 060 * 0.8241 ) = $984 . 14 quation