Suppose that a 1-year zero-coupon bond with face value $100 currently sells at $94.34, while a 2-year

Question:

Suppose that a 1-year zero-coupon bond with face value $100 currently sells at $94.34, while a 2-year zero sells at $84.99. You are considering the purchase of a 2-year-maturity bond making annual coupon payments. The face value of the bond is $100, and the coupon rate is 12% per year.

a. What is the yield to maturity of the 2-year zero? The 2-year coupon bond?

b. What is the forward rate for the second year?

c. If the expectations hypothesis is accepted, what are

(1) The expected price of the coupon bond at the end of the first year and

(2) The expected holding-period return on the coupon bond over the first year?

d. Will the expected rate of return be higher or lower if you accept the liquidity preference hypothesis?

Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Face Value
Face value is a financial term used to describe the nominal or dollar value of a security, as stated by its issuer. For stocks, the face value is the original cost of the stock, as listed on the certificate. For bonds, it is the amount paid to the... Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest...