Currently, the term structure is as follows: One-year bonds yield 9.75%, two-yea

Question

Currently, the term structure is as follows: One-year bonds yield 9.75%, two-year bonds yield 10.75%, three-year bonds and greater maturity bonds all yield 11.75%. You are choosing between one-, two-, and three-year maturity bonds all paying annual coupons of 10.75%, once a year. You strongly believe that at year-end the yield curve will be flat at 11.75%. a. Calculate the one year total rate of return for the three bonds. (Do not round intermediate calculations. Round your answers to 2 decimal places.) b. Which bond you would buy? One-year bond Two-year bond Three-year bond

Explanation / Answer

Return on 1 year bond

Initial price =PV(9.75%,1,-107.5,-1000,0) =1009.11

Final Price =PV(11.75%,0,-107.5,-1000,0)=1000

In the final price add coupons =1000+ 107.5 =1107.5

1009.11*(1+r) = 1098.55 =9.75

Initial price =PV(10.75%,1,-107.5,-1000,0) =1000

Final Price =PV(11.75%,1,-107.5,-1000,0)=991.05

Add coupns to the bond =991.05 + 107.5=1098.55

Yield = 8.88%

For the three year bond

PV(11.75%,3,-107.5,-1000,0) = 975.8

PV(11.75%,2,-107.5,-1000,0)=983.04

Add the coupon = 983.04 +107.5 =1090.54

=1090.75/975.8-1

=11.75%

Hence i would buy three year bond

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.