A three-year zero coupon treasury bill currently trades at $70.38. The Treasury plans to issue three-year coupon bonds with a 10% coupon rate. All treasury annual coupon bonds have a face value of $100.

(a) What is the yield to maturity of the three-year zero coupon bond? (2 points)

(b) At what price should the three-year coupon bond sell? (4 points)

(c) A bond analyst comments, without calculation, that he or she can decide whether a bond should be sold above its face value. How can it do this? Provide a short description. (3 points)

(d) If two bonds have the same maturity, same yield, and same level of risk, the bonds should be sold at the same price.” Do you agree that this is true? Give a brief explanation. (3 points)

(e) Lily manages a portfolio of bonds with the following Treasuries:

• 3-year zero coupon bonds
• 3-year 10% coupon bonds
• 10-year zero coupon bonds
• 10-year 10% coupon bonds

The market believes interest rates will rise over the next few months. Accordingly, it is recommended to do the following. Comment on each suggestion and give Lily your suggestions (for example, whether or not to accept the suggestion). (6 points)

1. Sell 3-year zero coupon bonds and buy 10-year zero coupon bonds
2. Buy 10-year zero coupon bonds and sell 10-year 10% coupon bonds

Answer rating: 100% (QA)

a To calculate the yield to maturity YTM of the threeyear zero coupon bond we use the formula YTM Face Value Current Price 1 Number of Years 1 Given Current Price 7038 Number of Years 3 since its a th... View the full answer