Question

The yield to maturity on 1-year zero-coupon bonds is currently 6.5%; the YTM on 2-year zeros is 7.5%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 8.5%. The face value of the bond is $100.

a. At what price will the bond sell? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)
Price___$
b. What will the yield to maturity on the bond be? (Do not round intermediate calculations. Round your answer to 3 decimal places. Omit the "%" sign in your response.)
Yield to maturity__%
c. If the expectations theory of the yield curve is correct, what is the market expectation of the price that the bond will sell for next year? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)
Price__$
d. Recalculate your answer to (c) if you believe in the liquidity preference theory and you believe that the liquidity premium is 1%. (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.)
Price___$.

Answer 1

1. PV = 101.87

2. YTM = 7.46%

3. Price of the bond is $100.92

Step-by-step explanation:

PV = 8.5/ (1.065) + 108.5/ (1.075)2

PV = 7.981 + 93.889

PV = 101.87

Part B:

PV = 101.870

FV = 100

N = 2

PMT = 8.5

Using Financial Calculator:

r = 7.459237

YTM = 7.46%

Part C:

The forward rate for next year, derived from the zero-coupon yield curve, is approximately:

(1 + forward Rate) = (1 + 0.075)2/ (1.065)

forward rate = 8.51%

Price of the bond = 108.5/ (1.0851)

Price of the bond = 100

Part D:

Interest Rate = 8.51% - 1% = 7.51%

Price of the bond = 108.5/ (1.0751)

Price of the bond = 100.92