Suppose that a 1-year zero-coupon bond with face value $1000 sells at $940, and a 2-year...

  

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Suppose that a 1-year zero-coupon bond with face value $1000 sells at $940, and a 2-year zero sells at $865 with same amount of face value. You are considering to purchase a 2-year- maturity bond making annual coupon payments. The face value of the bond is $1000 with coupon rate at 10%. (a) Compute the forward rate for the second year f2. Hint: what are the value of y₁ and y₂? (b) Under the expectations hypothesis, compute the (expected) holding period return on the coupon bond over the first year? Hint: What is the coupon bond price as the starting price? What is the selling price of this coupon bond at the end of first year as the ending price? (c) Now, suppose that the liquidity preference theory is valid in the market, will the (ex- pected) holding period return be higher or lower? Explain it. Suppose that a 1-year zero-coupon bond with face value $1000 sells at $940, and a 2-year zero sells at $865 with same amount of face value. You are considering to purchase a 2-year- maturity bond making annual coupon payments. The face value of the bond is $1000 with coupon rate at 10%. (a) Compute the forward rate for the second year f2. Hint: what are the value of y₁ and y₂? (b) Under the expectations hypothesis, compute the (expected) holding period return on the coupon bond over the first year? Hint: What is the coupon bond price as the starting price? What is the selling price of this coupon bond at the end of first year as the ending price? (c) Now, suppose that the liquidity preference theory is valid in the market, will the (ex- pected) holding period return be higher or lower? Explain it.

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a Value of 1year zero coupon bond y1 940 Value of 2year zero coup... View the full answer