You observe the following data on two default-free government bonds with face value $100

Bond  Maturity (years)   Coupon Rate    Price

A                  1                              0%                       $80                

B                   2                            20%                     $88

(a) Determine the 1-year and 2-year spot rates and the implied forward rate between years 1 and 2.

(b) The yield to maturity of bond B is 28.69%. Use the duration approach to estimate the dollar change in the price of the bond if its yield decreases by 100 basis points.

(c) Would the magnitude of the price change in (b) be larger or smaller if bond B was currently selling at par? Explain without the aid of any calculations (you will be assessed on the explanation provided).

Answer rating: 100% (QA)

a Spot Rates and Implied Forward Rate To calculate the spot rates we can use the formula Spot Rate F... View the full answer