Question 1

The following are the current coupon yields to maturity and spot rates of interest for six U.S. Treasury securities. Assume all securities pay interest annually. See table attached. Yield to Maturity Spot Rate of Interest 1 year Treasury 3.75% 2 year Treasury 4.09% 3 year Treasury 4.44% 4 year Treasury 4.61% 5 year Treasury 4.80% 10 year Treasury 5.45% 30 year Treasury 6.12%.

a. Compute the two-year implied forward rate three years from now, given the information provided in the preceding table. State the assumption underlying the calculation of the implied forward rate.

b. What is the value of a 5 -year, 8.0% coupon Treasury note. Interest paid annually. Assume $100 par value.

c. If the price of 6 -year, 7.5% coupon Treasury security is $90.00. What is the theoretical 6-year spot rate? Interest paid annually.

Question 2

a. Assume that you purchase a 4-year $1,000 par value bond, with an 6% coupon, and a yield of 5%. After you purchase the bond, one-year interest rates are as follow, year 1=5%, year 2=4%, year 3=3% (these are the reinvestment rates). Calculate the realized horizon yield if you hold the bond to maturity. Interest is paid annually.

b. A $1,000,13%,20-year bond has a yield of 11%. If the yield remains unchanged, how much will the bond value increase by in the next five years? Assume interest is paid semi-annually.

c. How you would use a zero-coupon bond to immunize a bond portfolio? Discuss why a zero-coupon bond is an ideal instrument in this regard.