An FI has purchased a two-year, $1,000 par value zero-coupon bond for $867.43. The FI will hold

Question:

An FI has purchased a two-year, $1,000 zero-coupon bond for $867.43. The FI will hold the bond to unless it needs to sell the bond at the end of one year for liquidity purposes. The current one-year interest rate is 7 percent and the one-year rate in one year is forecast to be either 8.04 percent or 7.44 percent with equal likelihood. The FI wishes to buy a put option to protect itself against a capital loss if the bond needs to be sold in one year.
a. What is the yield on the bond at the time of purchase?
b. What is the market-determined, implied one-year rate one year before What is the expected sale price if the bond has to be sold at the end of one year?
d. Diagram the bond prices over the two-year horizon.
e. If the FI buys a put option with an exercise price equal to your answer in part (c), what will be its value at the end of one year?
f. What should be the premium on the put option today?
g. Diagram the value for the put option on the two-year, zero-coupon bond.
h. What would have been the premium on the option if the one-year interest rates at the end of one year were expected to be 8.14 percent and 7.34 percent? Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...