Suppose you currently observe the following term structure of interest rates (annualized rates):r1 =2%,r2 =4%,r3 =8%,r4 =10%,r5 =13%,r6 =15%.Notation:ri standsfori- year interest rate. Given the above information:

a)

Find the prices of the following two bonds: (i) two-year bond with coupon rate 5% and

face value $1000 (paying coupons annually) and (ii) four-year bond with coupon rate

8% and with face value $1000 (paying coupons annually) and justify the methodology

you use for finding the prices of these bonds. Do these bonds sell at a discount or a

premium? Give reasons to your answer.

b)

Explain what the yield to maturity on a bond is and how you would find it. For the four- year and two-year bonds from (a) guess the magnitude of their yields (no need to

calculate the yields!) and give reasons to your guess.

(c)

Explain carefully the type of risk that investors face when investing in government bonds and how this risk is related to the upward-sloping term structure of interest rates.