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Question 2 (9 marks) The following is a list of yields to maturity for one-year, two-year, three-year, and four-year risk-free zero-coupon bonds. Maturity (Years) Yield

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Question 2 (9 marks) The following is a list of yields to maturity for one-year, two-year, three-year, and four-year risk-free zero-coupon bonds. Maturity (Years) Yield to Maturity 1 2 3 4 y = 3% y2 =4% y3 =6% Y4 =7% a). Suppose a three-year zero-coupon bond with a par value of $1,000 is to be issued at the end of Year 1, and you aim to make an investment of this bond at the issuance date. Assume that the expectations theory of term structure of interest rates holds, and you hold the three-year zero-coupon bond until maturity (i.e., the end of Year 4). Calculate the expected price of the three-year zero-coupon bond at the end of Year 1. (3 marks) Part b) is not related to Part a). b). Based on the current yield curve, a risk-free 3-year 10% annual coupon bond is issued today (i.e., to mature at the end of Year 3). You buy the coupon bond at the issuance, and reinvest the coupons until the end of year 2, and resell the bond at the end of Year 2. Assume that the expectations theory of term structure of interest rates holds. Calculate the price of the coupon bond at the issuance and the Realized Compound Yield for the investor over the two-year period. (6 marks) Question 2 (9 marks) The following is a list of yields to maturity for one-year, two-year, three-year, and four-year risk-free zero-coupon bonds. Maturity (Years) Yield to Maturity 1 2 3 4 y = 3% y2 =4% y3 =6% Y4 =7% a). Suppose a three-year zero-coupon bond with a par value of $1,000 is to be issued at the end of Year 1, and you aim to make an investment of this bond at the issuance date. Assume that the expectations theory of term structure of interest rates holds, and you hold the three-year zero-coupon bond until maturity (i.e., the end of Year 4). Calculate the expected price of the three-year zero-coupon bond at the end of Year 1. (3 marks) Part b) is not related to Part a). b). Based on the current yield curve, a risk-free 3-year 10% annual coupon bond is issued today (i.e., to mature at the end of Year 3). You buy the coupon bond at the issuance, and reinvest the coupons until the end of year 2, and resell the bond at the end of Year 2. Assume that the expectations theory of term structure of interest rates holds. Calculate the price of the coupon bond at the issuance and the Realized Compound Yield for the investor over the two-year period. (6 marks)

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