In this problem we are going to calculate bond prices and returns

Suppose that the yield on a 3 year note is 1.3%.

a) (10 points) Calculate the price of the 3 year note (face value = $1000) with three annual coupon payments (after year 1, after year 2, after year 3) of $25, i.e., the coupon rate is 2.5%.

b) (5 points) Is this note selling at a discount or premium? Explain.

Suppose that after one year and after you receive one coupon payment, you decide to sell your note. Your note is now a two year note with one coupon payment after 1 year and another after year 2. Consider the following two scenarios:

Scenario #1 - interest rates on what is now a two year note (i.e., your note) have fallen to 1.00%

Scenario #2 - interest rates on what is now a two year note (i.e., your note) have risen to 2%

c) (10 points) Calculate the price that you can sell your note for under scenario #1 and the associated rate of return when you sell your note given Scenario #1

d) (10 points) Calculate the price that you can sell your note for under scenario #2 and the associated rate of return when you sell your note given Scenario #2