Problem 4: Currently, 6-year Treasury securities yield 6.8%, a 10-year Treasury securities yield 7.2%, and a 3-year Treasury yields 7.4% in the future. If the expectations theory is correct, what does the market expect will be the yield on 1-year Treasury securities nine years from today?

Problem 5: A bond was issued on January 1^st, 2002. The bond has an 8 percent annual coupon and it will mature in 10 years, therefore the bond matures on December 31^st, 2012. You bought the bond on January 1^st, 2007. The bond has a call protection for the first 7 years, therefore the bond cannot be called until 2009, after which the bond can be called for a premium of 2 percent. Interest rates have steadily fallen recently due to looming recession. Therefore, the bond is selling at a premium of 5 percent at a current value of $1050. The face value of the bond is $1000.

What is the yield to maturity?

What is the yield to call if the bond is called as soon as it is possible?

Which return, yield to maturity or yield to call, do you think you as an investor would actually be earning? Explain your reasoning!

Problem 6: Due to a recession, expected inflation this year is only 3 percent. However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3 percent. Assume that the expectation theory holds and the real risk free rate r* = 2%. If the yield on a 3 year Treasury bond equals the 1 year yield plus 2 percent, what inflation rate is expected after year 1? The MRP is zero for all bonds.

Problem 7: Kennedy Gas Works has 10-year, $1,000 face value bonds that pay a 9% annual coupon. The bonds may be called in five years. The bonds have a nominal yield to maturity of 8% and a yield to call of 7.5%. What is the bonds call price?