Treasury bond of 18 months to maturity is about to be issued with a coupon rate of 10% per year (with semi-annual payments).

• Show that the price, per $1,000 face value, of the new bond should be approximately $1,001.80

• Is the bond selling at a premium or a discount? Why? Without doing any calculations can you say whether or not the yield to maturity will be different than the coupon rate?

• Suppose the coupon bond instead sells at par in the market. Describe how you can exploit this arbitrage opportunity to make money. En- sure that you clearly highlight the cash-flows of your strategy.

• Suppose the expectations theory of term structure holds. What is the markets expectation of the price of the 18-month zero coupon bond 1-year from today (assuming semi-annual compounding)?

• If the liquidity preference theory holds instead, is the expected price of the bond lower or higher than you calculated in part d? Explain.