Question: a) Let the continuously compounded zero interest rates for 6, 12 and 18 months be: r0.5 = 4%, r1 = 5%, and r1.5 = 5.9%,

a) Let the continuously compounded zero interest rates for 6, 12 and 18 months be: r0.5 = 4%, r1 = 5%, and r1.5 = 5.9%, p.a. respectively. Calculate the prices of a 6-month zero-coupon note, a 1-year bond with 7% annual coupon rate (semi-annual payment), and a 1.5-year coupon bond with 3% annual coupon rate (semi-annual payment). Assume a bond face value of 100.

b) Calculate the annualised yield to maturity for each security from question (a) and express it both in terms of semi-annual rates as well as continuously compounded rates. In what circumstances can you interpret the yield to maturity as a (certain) rate of return on a bond?

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