Problem 5 (Total 20 Points):

a) Suppose the following zero-coupon bonds are trading at the prices shown below per $150

face value. Determine the corresponding yield to maturity for each bond. (5 Points)

Maturity 1 year 2 years 3 years 4 years

Price $86.45 $82.25 $77.58 $73.42

b) Assume that it is January 15th, 2010 and the U.S. Treasury has just issued securities with

January 15th, 2018 maturity, $1000 par value and a 4% coupon rate with semiannual

coupons. Since the original maturity is only 8 years, these would be called "notes" as

opposed to "bonds". The first coupon payment will be paid on July 15th, 2010. What cash

flows will you receive if you hold this note until maturity? (5 Points)

c) Consider three 25-year bonds with annual coupon payments. One bond has a 4% coupon

rate, one has a 2% coupon rate, and one has a 1% coupon rate. If the yield to maturity of

each bond is 3%, what is the price of each bond per $150 face value? Which bond trades

at a premium, which trades at a discount, and which trades at par? (5 Points)

d) Why Bond Prices Change? (5 Points)