1. Consider the following investment strategies: a. b. Under certainty, the yield curve suggests that neither...
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1. Consider the following investment strategies: a. b. Under certainty, the yield curve suggests that neither entails any risk and so both strategies must provide equal returns. Mathematically, this can be expressed as (1 + y) = (1 + Yn-1)-1 x (1 + r) (1) where n denotes the period of maturity. Yn is the yield to maturity of a zero-coupon bond with an n-period maturity, and r,, is the short-rate in the last period. a. b. Buying and holding an n-year zero-coupon bond Buying an (n-1)-year zero-coupon bond and rolling over the proceeds into a 1- year bond C. Let fn denote the forward rate for period n. Construct the formula for (1 + fn) based on the result in Equation (1). [2.5 marks] Suppose ₁ = 5% and E(1₂) = 6%. In addition, suppose that the liquidity premiums are zero. Calculate y2. [5 marks] In Question 1b. above, suppose that we observe y₂ = 6.49%. Calculate f₂. [5 marks] 1. Consider the following investment strategies: a. b. Under certainty, the yield curve suggests that neither entails any risk and so both strategies must provide equal returns. Mathematically, this can be expressed as (1 + y) = (1 + Yn-1)-1 x (1 + r) (1) where n denotes the period of maturity. Yn is the yield to maturity of a zero-coupon bond with an n-period maturity, and r,, is the short-rate in the last period. a. b. Buying and holding an n-year zero-coupon bond Buying an (n-1)-year zero-coupon bond and rolling over the proceeds into a 1- year bond C. Let fn denote the forward rate for period n. Construct the formula for (1 + fn) based on the result in Equation (1). [2.5 marks] Suppose ₁ = 5% and E(1₂) = 6%. In addition, suppose that the liquidity premiums are zero. Calculate y2. [5 marks] In Question 1b. above, suppose that we observe y₂ = 6.49%. Calculate f₂. [5 marks]
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