Question

The following table shows the prices of a sample of Treasury bonds, all of which have coupon rates of zero. Each bond makes a single payment at maturity.
Years to Maturity Price (% of face value)
1 96.852%
2 93.351
3 89.544
4 85.480
a) What is the 1-year interest rate?
b) What is the 2-year interest rate?
c) What is the 3-year interest rate?
d) What is the 4-year interest rate?
e) Is the yield curve upward-sloping, downward-sloping, or flat?
f) Is this the usual shape of the yield curve

Answer 1

a) The 1-year interest rate is 3.25%.

b) The 2-year interest rate is 7.12%.

c) The 3-year interest rate is 11.68%.

d) The 4-year interest rate is 16.99%.

e) The yield curve is always upward-sloping.  With increased time to maturity, interest rate increases to compensate for the increased risks associated with a longer term.

f) Yes.  The usual shape of the yield curve is upward-sloping because short-term securities generate lower yields than long-term debt instruments.

What is the interest rate?

The interest rate is the compensation for undertaking financial risks in view of the time value of money.

The interest rate depends on two factors, the maturity period and the implied risks involved.

The interest rate can be computed using the following yield-to-maturity formula:

YTM Formula = (100%/Price %) - 1

Years to      Price (% of       Interest rate =

Maturity      face value)     (100%/Price %) - 1

1                    96.852%        3.25% (100/96.852 - 1)

2                   93.351%         7.12% (100/93.351 - 1)

3                   89.544%       11.68% (100/89.544 - 1)

4                   85.480%      16.99% (100/85.480 - 1)

Learn more about the interest rate and yield-to-maturity at brainly.com/question/28033398

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