Question
Spot interest rates prevailing in the market right now are: 1-year spot rate = 1% 2-year spot rate = 3% 3-year spot rate = 5%
Spot interest rates prevailing in the market right now are:
1-year spot rate = 1%
2-year spot rate = 3%
3-year spot rate = 5%
A Treasury bond that was issue 5 years ago offers a 3.5% coupon rate and matures in 3 years.For simplicity, assume annual interest payments.Calculate this bond's price and its ytm (again, calculate to the nearest 1/10th of 1 basis point).Another Treasury bond was issued 27 years ago, and it also has 3 years remaining before it matures.It pays interest annually, but its coupon rate is 10%.Use the spot rates above to calculate this bond's current market price and its ytm.Because these two bonds have the same maturity and the same risk, should they be priced to offer investors the same ytm?What do the calculations say?Explain.Use the ytm of the 3.5% coupon bond to calculate the price of the 10% bond.How large is your "pricing error" using this approach?
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