Question 1.

The following table gives the price of bonds:

Bond Principal ($)	Time To Maturity (Months)	Annual Coupon Rate (%)	Bond Price ($)
100	6	0.0	96
100	12	0.0	90
100	18	8.0	95

Half the stated coupon is assumed to be paid every six months. Use semi-annual compounding as interest rate measurement.

Part I.

Calculate (annualized) zero rates for maturities of 6 months, 12 months and 18 months.

(6 Marks)

Part II.

What is the fair price of 18-months zero-coupon bond given current term structure of zero rates? The par value of bond is assumed to be $100.

(2 Marks)

Part III.

Assume you are treasury manager in a company and the company requires $1,000,000 ($1 Million) in 6 months for the duration of 1 year. You can finance this need by trading zero-coupon bonds, i.e., buying or selling zero-coupon bonds or go to bank to organize a forward contract.

The bank quotes a forward rate 14% per annum semi-annual compounding applied from 6 months to 18 months. The prices of zero-coupon bonds with maturity 6 months and 12 months are listed in the above table and the price of zero-coupon bond with maturity 18 months is calculated in Part II.

Ignoring all the other costs and given all the information above, are you going to accept the bank's offer? Justify your decision.