(25pts) Consider the following yield curve for risk-free zero coupon bonds. Year Spot rate 1 3%...

  

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(25pts) Consider the following yield curve for risk-free zero coupon bonds. Year Spot rate 1 3% 2 4% 3 5% 4 4.5% 5 4% (1) (5pts) Without doing any calculations, what does the yield curve imply about the market's prediction of the movement of short-term rates in the future? (2) (3pts) Calculate the expected 1-year interest rate 3 years from now. (3) (7pts) You are interested in pricing a five-year corporate bond with face value $1000 and coupon rate 6%. Since this bond has default risk, you estimate that the default risk premium for each maturity is 2%. This means, for example, the annual interest rate to discount year 2's coupon would be 4%+2% -6%. Calculate the bond price. * (4) (6pts) Calculate the realized compound return of holding this corporate bond to maturity if all coupon payments are fully made and you can reinvest them at 3% per year, but 60% of the face value is not paid on the maturity date.. (5) (4pts) How can you hedge the default risk of the corporate bond? (25pts) Consider the following yield curve for risk-free zero coupon bonds. Year Spot rate 1 3% 2 4% 3 5% 4 4.5% 5 4% (1) (5pts) Without doing any calculations, what does the yield curve imply about the market's prediction of the movement of short-term rates in the future? (2) (3pts) Calculate the expected 1-year interest rate 3 years from now. (3) (7pts) You are interested in pricing a five-year corporate bond with face value $1000 and coupon rate 6%. Since this bond has default risk, you estimate that the default risk premium for each maturity is 2%. This means, for example, the annual interest rate to discount year 2's coupon would be 4%+2% -6%. Calculate the bond price. * (4) (6pts) Calculate the realized compound return of holding this corporate bond to maturity if all coupon payments are fully made and you can reinvest them at 3% per year, but 60% of the face value is not paid on the maturity date.. (5) (4pts) How can you hedge the default risk of the corporate bond?

Answer rating: 100% (QA)

1 The yield curve implies that the market expects shortterm interest rates to remain the same or dec... View the full answer