Use the following table to answer the questions below: Bond Par Value Years to M

Question

Use the following table to answer the questions below: Bond Par Value Years to Maturity Yield to Maturity Coupon Rate A $1000 1 2% 0% B $1000 2 4% 0% C $1000 3 7% 0% D $1000 4 9% 0% A. Calculate the short rates r1, r2, r3 and r4. B. Suppose an agent buys bonds B, C and D, holds them for one year and then sells them all. Find the price the agent will be able to sell each of the three bonds at. C. Based on the prices you found in C., write expressions for the Holding Period Returns of bonds B, C and D and observe that the Holding Period Returns are the same.

Explanation / Answer

r1 = 1+rate2^2/1+rate ^1 = 1.04^2/1.02;= 1.060392 = 6.03%

r2 = 1+ rate2 ^3/1+rate^1 = 1.07^3/1.02 =20.10%

The market price of bonds today are

A 1000 PVIF(2%,1) = 980.39

B 1000PVIF(4%,2) = 924.56

C 1000 PVIF(7%,3) = 816.30

D 1000 PVIF (9%,4) = 708.43

If all the bonds are sold after 1 year the return will be same as YTM of the bond since rate of bond is considered same as the interest of bond.

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