The yield to maturity on 1-year zero-coupon bonds is currently 6%; the YTM on 2-year zeros is 7%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 8%. The face value of the bond is $100.
a) At what price will the bond sell?
b) What will the yield to maturity on the bond be?
c) If the expectations theory of the yield curve is correct, what is the market expectation of the price that the bond will sell for next year?
d) Recalculate your answer to (c) if you believe in the liquidity preference theory and you believe that the liquidity premium is 2.5%.
The yield to maturity on 1-year zero-coupon bonds is currently 6%; the YTM on 2-year zeros is 7%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon rate of 8%. The face value of the bond is $100.
a) At what price will the bond sell?
b) What will the yield to maturity on the bond be?
c) If the expectations theory of the yield curve is correct, what is the market expectation of the price that the bond will sell for next year?
d) Recalculate your answer to (c) if you believe in the liquidity preference theory and you believe that the liquidity premium is 2.5%.
Related questions
Arthur plans to invest 10,000 dollars in a ten-year bond of a technology company: Face Tech. Inc. The bond offers an 8 percent annual coupon and a yield to maturity of 10 percent. He plans to sell the bond in 4 years and invest the proceeds in a 3-year default-free zero coupon bond and cash. All bonds have a face value of $1000 per unit. The yield curve for the default free zero coupon bonds is provided in the following table:
| Default free zero coupon bond with face value of $1000 | Yield to Maturity |
| 1-year Bond | 7% |
| 2-year Bond | 8% |
| 3-year Bond | 9% |
| 4-year Bond | 10% |
| 5-year Bond | 12% |
| 6-year Bond | 13% |
| 7-year Bond | 14% |
| 8-year Bond | 15% |
(a) If Arthur can invest the coupons at an annual rate of 7 percent, and 4 years later, this coupon bond of Face Tech. Inc. can sell at a yield to maturity of 8.5%, what is his annualized holding period return on this bond?
(b) After Arthur collected his proceeds from his investments in Face Tech. Inc. 4 years later, he will use the money to purchase 8 units of a 3-year default-free zero coupon bond and put the rest in cash. What are the percentage weights in the 3-year default-free zero coupon bond and cash (out of Arthur's total proceeds), respectively? Assume that the yield curve on zero coupon bonds stays the same and you can ignore the liquidity premium.
| An eBay bond has 25 years until maturity and the coupon rate is 4.0%. The quoted price of the bond is 77.334 and the yield to maturity is 5.667%. The yield to maturity on a U.S. Treasury bond with 26 years until maturity is 2.696%. Assuming a liquidity risk premium of zero, what is the default risk premium on the eBay bond? |
