Question
The yield to maturity on 1-year zero-coupon bonds is currently 6%; the YTM on 2-year zero-coupon bonds is 7%. The Treasury plans to issue a
The yield to maturity on 1-year zero-coupon bonds is currently 6%; the YTM on 2-year zero-coupon bonds is 7%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 8%. The face value of the bond is $1000. (Note: In this question, the rates are annual rates compounded annually, rather than compounded semi-annually)
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At what price will the bond sell?
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Will the yield to maturity on the bond be larger than 6.5% or smaller than 6.5%? Explain.
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(Note: you dont have to calculate the exact value of YTM)
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If the expectations theory of the yield curve is correct, what is the market expectation of the
price for which the bond will sell next year (a year from now)?
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Recalculate your answer to part (c) if you believe in the liquidity preference theory and you
believe that the liquidity premium is 1%.
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