Question 4 (25 marks / Bond Market and Term Structure of Interest Rates)

1. a) You are considering investing in bonds and have collected the following information about the prices of a 1-year zero-coupon bond and a 2-year coupon bond.

   • - The 1-year discount bond pays $1,000 in one year and sells for a current price of $950.

   • - The 2-year coupon bond has a face value of $1,000 and an annual coupon of $60. The bond currently sells for a price of $1,050.

   1. i) What are the implied yields to maturity on one- and two-year discount bonds?(6 marks)

   2. ii) What is the implied forward rate between years 1 and 2? (3 marks)

   3. iii) Consider a 2-year annuity with annual coupon payments of $800. What is the most that you would be willing to pay for this annuity? (4 marks)