Suppose you have a 1-year investment horizon and you are considering three risk-free bonds. All bonds have a face value of 1000 and mature in 10 years. The bonds are priced today such that the (annual) yield to maturity is 5%. The first bond is a zero-coupon bond with a current price of 613.91. The second bond has an annual coupon rate of 5% and a current price of 1000. The third bond has an annual coupon rate of 7% and a current price of 1154.43. Assume that the next coupon payments will be one year from now.

1. Suppose you expect that the yield to maturity for each bond will still be 5% at the beginning of next year. What will be the prices of the three bonds one year from now? [Hint: One year from now, the bonds will have 9 more years to maturity.] ANSWER: We get, price of the bond as $1,142.16
2. For each bond, calculate the holding period return (i.e. the net simple return) if you buy the bond today and sell it one year from now (just after collecting the first coupon payment for the coupon bonds). Answer 0.05 or 5%
3. Now suppose you expect that the yield to maturity for each bond will be 4% at the beginning of next year. Recalculate your answers to parts (a) and (b) for each bond. (Note: the current bond prices stay the same.)

   Calculation of holding period return(HPR)

   HPR=[Annual coupon+(Price in 1 year-Current price)/Current price]*100

   Thus HPR for :

   A)Zero coupon bond is:

   =[0+(702.59-613.91)/613.91]*100

   =14.45%

   B)5%coupons bond is:

   =[50+(1074.35-1000)/1000]*100

   =12.44%

   C)7% coupon bond is:

   =[70+(1223.60-1154.43)/1154.43]*100

   =12.06%

4. Compare the holding period returns in part (b) and (c) to the initial yield of 5% and provide a brief intuitive explanation for this result.
5. Take the holding period returns from part (b), where the yield stays constant at 5%. If inflation is 3%, what is the real return on each bond in the first year? Considering this result and the result in part (d), are the bonds really risk-free investments?
6. Calculate the duration of each of the three bonds (using the yield of 5% and ). Which bond is the most sensitive to changes in the yield, and which bond is the least sensitive? Provide a brief intuitive explanation.

QUESTION 1, 2 and 3 is solved plz help in Q4-Q6

ANSWER for 1, 2 and 3 is given after each question.