Consider the following interest rates on four zero-coupon bonds. Maturity (years

Question

Consider the following interest rates on four zero-coupon bonds.

Maturity (years)

Spot rate

1

6.0%

2

6.5%

3

7.0%

4

7.5%

What is the forward rate for a two-year loan beginning one year from now?

A.

6.75%

B.

6.50%

C.

7.50%

D.

7.75%

Three bonds were issued by the same company about four years ago. The three bonds have similar maturities and coupons. Bond A is callable, Bond B is putable, and Bond C is option-free.

Statement 1: If interest rates decline, Bonds B and C will have higher market prices than Bond A.

Statement 2: If interest rates increase, Bonds A and C will have higher market prices than Bond B.

A.

Both statements are correct.

B.

Both statements are not correct.

C.

Only statement 1 is correct.

D.

Only statement 2 is correct.

Maturity (years)

Spot rate

1

6.0%

2

6.5%

3

7.0%

4

7.5%

Explanation / Answer

1. Forward rate = (1.073/1.06)1/2 - 1 = 7.50%

2.

Only statement 1 is correct based on the two statements

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