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Q1 Suppose the following bonds are trading in the market. In addition to the bonds above, you also observe the 1-year forward rate in 2
Q1 Suppose the following bonds are trading in the market. In addition to the bonds above, you also observe the 1-year forward rate in 2 year's time, 2f3 is 8.50%. You wish to price Bond H, which is 4-year 10% coupon bond with a face value of $100. Assume all bonds (and the forward rate) are risk-free and that Bond F and Bond H are annual coupon bonds. a. Infer the term structure of interest rates: y1,y2,y3 and y4. These are the yield on the pure yield curve for years 1-4. b. Price Bond H using the pure yield curve. c. Based on the pure yield curve, infer the 2-year forward rate commencing in 2 year's time 2f4. d. Assume Liquidity Preference Theory holds and the annual liquidity premium is flat at 1.00% for all t. What is the expected future 1-year spot rate in 3 year's time E[3y4] ? e. Assume the Expectations Hypothesis holds. What is the expected 1-year future spot rate in 1 year's time E[1y2]
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