Consider the following risk-free T-bill and coupon bonds available for sale in t

Question

Consider the following risk-free T-bill and coupon bonds available for sale in the bond market (annual coupons): Maturity Price Coupon 1 942 T-bill 2 995 6.3% 3 998 7.5% 4 985.25 6.75% a) Find term structure of interest rates b) You plan to issue four-year maturity bonds priced at $980. At what level should you plan to set the coupon on your bond? c) Your company does not have money to pay coupons, and thus plans rather to issue discount bonds instead of coupon bonds. At what price do you expect to sell the zero-coupon bonds with the same, four year maturity

Explanation / Answer

Step-1:

Calculation of Interest rates:

= 63 / 995

= 0.063

= 75 / 998

= 0.075

= 66.50 / 985.25

= 0.0675

Step-2:

Current yield = Annual coupon / market value

                      = 942 / 980

                     = 0.9612 or 96.12

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