Question

You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is $1000 and the one-year and 11-year spot interest rates are 5 and 7 percent respectively. What is the forward price of your contract

Answer 1

Answer:

$498.94

Explanation:

1 year interest rate = 5%

11 year interest rate = 7%

10 year spot interest rate at end of 1 year = [{(1+0.07)^11 / (1+0.05)}^(0.1) - 1]

10 year spot interest rate at end of 1 year = [(2.104852/1.05)^0.1] - 1

10 year spot interest rate at end of 1 year = 1.07202083615 - 1

10 year spot interest rate at end of 1 year = 0.072021

10 year spot interest rate at end of 1 year = 7.202%

Face value = $1,000

Forward Price of contract = $1000/(1+0.0720)^10

Forward Price of contract = $1000/2.00423136

Forward Price of contract = 498.944392915

Forward Price of contract = $498.94