Answered: Suppose that a 2-year zero-coupon bond…

Essentials of Economics (MindTap Course List)

8th Edition

ISBN:9781337091992

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter19: The Basic Tools Of Finance

Section: Chapter Questions

Problem 3PA

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Suppose that a 2-year zero-coupon bond with face value $1,000 currently sells at $840, while a 1-year zero-coupon bond with face value $1,000 currently sells at $920. You are considering the purchase of a 2-year coupon bond that pays coupon annually. The face value of this coupon bond is $1,000 and coupon rate is 12% per year.

Required:

a. What is the yield to maturity of the 2-year zero-coupon bonds?

b. What is the current price of the 2-year coupon bond?

c. What is the forward rate of the second year?

d. If the expectation hypothesis is accepted, what are (1) the expected price of the coupon bond at the end of the first year and (2) the expected holding period return on the coupon bond over the first year?

e. Will the expected rate of return be higher or lower if you accept the liquidity preference hypothesis?

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