If a pure discount three-year bond sells for $782 and a pure discount four-year bond sells for $733, what is the expected 12-month interest rate in three years time? Both have a face value of $1000.



2. If 12-month interest rates are expected to be 6% in three years time, describe how investors could take advantage of the pricing in question 1. What impact would this have on interest rates?



3. Twelve-month interest rates for the next four years are expected to be 5%, 6%, 6.8% and 7.4% respectively. Calculate the yield to maturity on:

i) a pure discount four-year bond, and

ii) a four-year 8% annual coupon bond.

Explain why there is a difference.



4. An investor purchases the following debt instruments with a $1,000 face value, for $826.44 and $1,000 respectively.

i) a pure discount two-year bond, and

ii) a two-year 10% annual coupon bond

Calculate the return after two years if immediately after purchase interest rates

a) fall by 1% p.a.

b) remain constant, and

c) increase by 1`% p.a. on all maturities.

(Assume that the yield curve is flat).