Question 1 (15 points 5 each) Suppose that a 1-year zero-coupon bond with a face value of $100 currently trades at $94.34, while a 2-year zero trades at $84.99. You are considering the purchase of a 2-year maturity bond making annual coupon payments. The face value of the bond is $100, and the coupon rate is 12%.

What is the yield to maturity of the 2-year zero?

What is the yield to maturity of the 2-year coupon bond?

Why do the yields to maturity in parts (a) and (b) differ? (one sentence is all that is required)

Question 2 (20 points 5 each) A 3-year 5% coupon bond with annual payments (face value = 100) currently trades for 100.

Calculate the duration (in years).

Now suppose that yields go up to by 100 basis points. Calculate the approximate dollar change in the price of the bond using duration.

Will the actual dollar change be bigger or smaller than the dollar change you computed in part (b). Please only answer with the word BIGGER or SMALLER.

In ONE word, what is the reason for the difference?