Consider a par bond with face value $100, maturity T=2 years and 10% coupon rate.

1. Its YTM is y= ??? % (answer an integer e.g. 5%)

2. Its price is P= ???? $ (answer an integer e.g. $80)

Let's compute the duration of this bond. It is given by D = w1*1 + w2*2 where w1 = (10/(1+y) )/P and w2 = (110/ (1+y)^2) / P.

Hint: the weight w1 is equal to w1=0.09.

The bond's duration is ??? years. (answer with 1 decimal, e.g. 1.5).

According to the expectations hypothesis (EH), long-maturity yields reflect expectations about future short-maturity yields. Suppose the EH is false. Specifically, suppose that (1+Y(2))^2 > (1+Y(1))*(1+E[Y(1)]), where the expectation is for next year's one-year rate. What can you conclude?

• A. Investors are not risk-neutral or some other assumption behind the EH does not hold.
• B. There is an arbitrage opportunity of buying the two year-bond (lending for two years), while also selling the one-year bond today and selling next year's one-year bond next year (borrowing today for one year and repaying in a year by borrowing for another year).
• C. There is an arbitrage opportunity of selling the two year-bond (borrowing for two years), while also buying the one-year bond today and buying next year's one-year bond next year (lending today for a year and lending again in a year for one more year).
• D. All of the above.