Today (10/13/20), the prices on zero-coupon US Treasury STRIPS are as follows:

Maturity Price Effective Annual

In years (per $1000 in face value) YTM

1 985.000 ______________

2 952.000 ______________

3 917.500 ______________

4 871.442 .0350000

5 821.927 .0400000

Questions:

a. What are the yields to maturity for each of these zeros? Fill in the banks above. (3 points, 1 point each)

b. You think that short-term interest rates will rise over the next year. In particular, you think that the 1-year and the 2-year rates will be higher than they are currently. If you invest in the two-year now and sell it in one year, will your return be higher or lower than what you could get by investing in the one-year and holding it until maturity? If it depends, what does it depend upon? (5 points)

c. What is the forward rate implied by the above zero yield curve for the 2-year zero effective annual yield two years from now (i.e., the rate for a 2-year zero on 10/08/21)? (4 points)

d. There is a 5 year corporate bond currently trading in the market that pays a 5 percent coupon, with (for simplicity) coupon payments made once a year at the end of the year (with the next coupon paid exactly one year from now). The current price of this bond is $1020.

What would be the price of this bond if the market considered this corporation to be free of default risk? (4 points)

e. At the price the corporate bond would be if it where default free (i.e., your answer to d above, if you did it correctly), its effective annual yield to maturity to be .03895 (3.895%). At its actual market value of $1020, is its actual yield to maturity higher, lower, or equal to 3.895%.

Circle one: higher lower equal to

Explain why

(4 points total)

(Please only answer part E)