Answer:
Check the explanation
Explanation:
Let’s assume that a one/1-year zero-coupon bond with facial value of $100 sells for $89.75 as at present, while a 2year zero sells at a figure of $79.88. You are contemplating the purchase of a 2year maturity bond making yearly coupon payments. The facial value of the bond is $100, and the coupon rate is 10% per year.
a. the yield to maturity of the 2-year zero, y2 = (100 / 79.88)1/2 - 1 = 11.89%
b. the yield to maturity of the 1-year zero, y1 = (100 / 89.75) - 1 = 11.42%
Price of a 2 year coupon bond, P0 = 10 / (1 + y1) + 110 / (1 + y2)2 = 10 / (1 + 11.42%) + 110 / (1 + 11.89%)2 = 96.843
Hence, YTM of the 2 year coupon bond = Rate (Period, PMT, PV, FV) = RATE (2,10, -96.843, 100) = 11.86%
c. The forward rate for the second year, F12 = (1 + y2)2 / (1 + y1) - 1 = (1 + 11.89%)2 / (1 + 11.42%) - 1 = 12.36%
d. If the expectations hypothesis is accepted:
(1) the expected price of the coupon bond at the end of the first year, P1 = 110 / (1 + F12) = 110 / (1 + 12.36%) = 97.90
and (2) the expected holding-period return on the coupon bond over the first year = (P1 + Coupon - P0) / P0 = (97.90 + 10 - 96.843) / 96.843 = 11.42%
e. the correct answer to question E is the second option showing: Lower
