Question $4.$

The current yield curve for default$-$free zero$-$coupon bonds is as follows:

All bonds considered in this question have a face value of $$1,000.$ Assume that the pure

expectations hypothesis of the term structure holds.

a$.$ If market expectations are accurate, what are the expected yields to maturity on $1-$

and $2-$year zero coupon bonds next year?

$(3$ marks$)$

b$.$ If you purchase a $3-$year zero$-$coupon bond now, what is the expected total rate of

return over the next year assuming that you will sell the bond at the expected price

$($price that matches the expected yield in part a$))?$ Ignore taxes.

$(3$ marks$)$

c$.$ What should be the current price of a $3-$year maturity bond with a $12\%$ coupon

rate paid annually?

$(3$ marks$)$

d$.$ If you purchase now the coupon bond at the price you calculated in part c$),$ what

would your total expected rate of return over the first year be $($coupon plus price

change$)?$ Ignore taxes.

$(3$ marks$)$

$($Total for Question: $12$ marks$)$