ControlJane Nguyen is a senior bond trader for an investment bank, and Chris Alexander is a junior bond trader at the bank. Nguyen is responsible for her own trading activities and also for providing assignments to Alexander that will develop his skills and create profitable trade ideas. Exhibit $1$ presents the current par and spot rates.

EXHIBIT $1$ Current Par and Spot Rates

Maturity Par Rate Spot Rate

One year $2\mathrm{.}50\%2\mathrm{.}50\%$

Two years $2\mathrm{.}99\%3\mathrm{.}00\%$

Three years $3\mathrm{.}48\%3\mathrm{.}50\%$

Four years $3\mathrm{.}95\%4\mathrm{.}00\%$

Five years $4\mathrm{.}37\%$

Note: Par and spot rates are based on annual$-$coupon sovereign bonds.

Nguyen gives Alexander two assignments that involve researching various questions:

Assignment $1$: What is the yield$-$to$-$maturity of the option$-$free, default$-$risk$-$free bond presented in Exhibit $2?$ Assume that the bond is held to maturity, and use the rates shown in Exhibit $1.$

EXHIBIT $2$ Selected Data for $$1,000$ Par Bond

Bond Name Maturity $($T$)$ Coupon

Bond Z Three years $6\mathrm{.}00\%$

Note: Terms are today for a T$-$year loan.

Assignment $2$: Assuming that the projected spot curve two years from today will be below the current forward curve, is Bond Z fairly valued, undervalued, or overvalued?

After completing his assignments, Alexander asks about Nguyen$$s current trading activities. Nguyen states that she has a two$-$year investment horizon and will purchase Bond Z as part of a strategy to ride the yield curve. Exhibit $1$ shows Nguyen$$s yield curve assumptions implied by the spot rates.

Based on Exhibit $1,$ the five$-$year spot rate is closest to:

$4\mathrm{.}40\%.$

$4\mathrm{.}45\%.$

$4\mathrm{.}50\%.$

Based on Exhibit $1,$ the market is most likely expecting:

deflation.

inflation.

no risk premiums.

Based on Exhibit $1,$ the forward rate of a one$-$year loan beginning in three years is closest to:

$4\mathrm{.}17\%.$

$4\mathrm{.}50\%.$

$5\mathrm{.}51\%.$

Based on Exhibit $1,$ which of the following forward rates can be computed?

A one$-$year loan beginning in five years

A three$-$year loan beginning in three years

A four$-$year loan beginning in one year

For Assignment $1,$ the yield$-$to$-$maturity for Bond Z is closest to the:

one$-$year spot rate.

two$-$year spot rate.

three$-$year spot rate.

For Assignment $2,$ Alexander should conclude that Bond Z is currently:

undervalued.

fairly valued.

overvalued.

By choosing to buy Bond Z$,$ Nguyen is most likely making which of the following assumptions?

Bond Z will be held to maturity.

The three$-$year forward curve is above the spot curve.

Future spot rates do not accurately reflect future inflation.